2020 Conversations with Audit Committee Chairs

February 2021

This document represents the views of PCAOB staff and not necessarily those of the Board. It is not a rule, policy, or statement of the Board. The PCAOB does not set standards for, or provide authoritative guidance on, audit committee conduct. 2020 Conversations with Audit Committee Chairs

This document summarizes the feedback we OVERVIEW received in each topic area. Please note that the PCAOB does not necessarily endorse what The Public Company Accounting Oversight we heard from audit committee chairs. Rather, Board (PCAOB) views engaged and informed we present this summary in an effort to provide audit committees as effective force multipliers greater transparency into these important in promoting audit quality and believes that conversations. the PCAOB and audit committees jointly benefit from our ongoing dialogue. Continuing with the expanded engagement we launched in 2019, we again reached out to the audit 2020 Inspections committee chairs of most of the U.S. public companies whose audits we inspected during by the Numbers 2020 and offered them the opportunity to speak with our inspection teams. In total, we Number of audit spoke to nearly 300 audit committee chairs. firms reviewed by our inspectors, In addition to the effects of the COVID-19 219 which includes: pandemic on the audit, we discussed three core topics during our conversations: yy 11 U.S. firms with more than 100 issuer audit clients; yy The auditor and communications with the audit committee; yy 103 U.S. firms with 100 or fewer issuer audit clients; y y New auditing and accounting standards; and yy 66 U.S. firms that audit broker- yy Emerging technologies. dealers; and yy 39 Non-U.S. firms in over 19 jurisdictions. COVID-19

An overarching theme of our calls in 2020 was how the COVID-19 pandemic created Expanding our unprecedented challenges for auditors, audit committees, and public companies. Audit Committee We previously reported on that topic in Engagement Conversations with Audit Committee Chairs: COVID-19 and the Audit. Percentage of We also published two other documents— audit committee COVID-19: Reminders for Audits Nearing chairs that we Completion and Staff Observations 75% spoke to in 2020 and Reminders during the COVID-19 with whom we had not previously directly Pandemic—that include reminders engaged. For audit committee chairs of about certain auditor responsibilities, public companies not audited by one of notwithstanding the challenges that may the four largest public accounting firms, exist related to COVID-19. this percentage was 90%.

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THE AUDITOR AND yy Independence communications; yy Guidance around auditing of certain COMMUNICATIONS controls for third-party vendors;

WITH THE AUDIT yy “Over-auditing” and/or “over- COMMITTEE documentation;” and yy Increased visibility into and discussion We asked audit committee chairs a number around fee changes. of questions related to their audit firm and ongoing communications between the audit Reviewing Inspection Reports committee and their auditors. with Auditors Communications We asked audit committee chairs if they Audit committee chairs frequently cited reviewed PCAOB inspection reports with their communications with their auditors—both auditors. While there were varying degrees and verbal and written—as extremely important to types of reviews, audit committee chairs who audit quality and their overall relationship with did review the reports and had conversations their auditors. Most audit committee chairs with their auditors about them generally found commended their auditors’ communications, the exercise to be useful. Audit committee commonly sharing that they were thorough, chairs continued to cite the lag between when timely, and at the right level of detail and frequency. Several also highlighted their appreciation for dashboards provided by their New Format for PCAOB auditors that highlighted real-time data on audit progress and other topics. Inspection Reports Auditor Strengths and Areas for In 2020, we began issuing inspection reports in a redesigned format, the first Improvement substantial change to the inspection report Audit committee chairs noted that their in more than 15 years. We streamlined the auditors performed well in areas such as content to enhance readability and used assigning resources with expertise on complex charts and graphs to make the information accounting issues, consulting their national more digestible and accessible. To offices as appropriate, offering practical enhance transparency, we also included approaches to problem-solving (as opposed information not previously communicated to being highly theoretical), and providing in inspection reports. continuity on audit teams. The response from audit committee Innovation and partner rotation were areas chairs to the new format has been where some audit committee chairs praised overwhelmingly positive, with many their auditors, but others flagged them as areas noting that the reports are more concise, needing improvement. Other potential areas of better organized, easier to read, and improvement that were identified included: generally more useful. We encourage audit committee members to read our Guide yy Managing global audit operations; to Reading the PCAOB’s New Inspection Report and to share your feedback. yy Helping more junior audit team members learn the company’s business;

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inspections occur and when inspection reports are issued as an area of concern. Reducing that lag remains an important strategic priority for Audit Committee the PCAOB. Perspectives: What’s Awareness of Auditors’ Initiatives Working Well to Prevent Audit Deficiencies Asking the external auditors to We sought to gauge the understanding of provide constructive feedback or audit committee chairs about the activities tangible recommendations on or initiatives that they observed audit firms areas where the company’s internal undertaking to prevent audit deficiencies, audit team or financial reporting which is a significant area of strategic focus for systems could improve. the PCAOB. Their responses to our questions largely centered on: Asking the audit firm if they have yy Audit firms’ use of emerging technologies; training or resources for new audit committee members or a newly yy Audit firms’ emphasis on tone at the top; appointed chair. yy The role of robust training as a guard against deficiencies; and Regularly assessing the yy The importance of auditors staying focused engagement team’s performance. on implementation of new accounting and auditing standards. Asking the auditors to review the PCAOB inspection report Assessing Auditor Performance with the audit committee and Finally, we inquired about audit committees’ to discuss any initiatives the firm assessments of their auditors. Many audit has implemented to address committee chairs noted that they routinely deficiencies described in the assess the performance of their auditors, often inspection report. with an emphasis on the lead engagement partner and the engagement team’s Reviewing year-over-year PCAOB communications and timeliness. While some inspection report trends within committees do it on an annual basis or in and between audit firms. conjunction with the decision to include the ratification of the auditors in the annual proxy, many shared that they are conducting such assessments more regularly—either quarterly or in real time should the need for feedback arise.

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NEW AUDITING Audit Committee AND ACCOUNTING Perspectives: What’s STANDARDS Working Well The next area of focus in our conversations was the implementation of new auditing When reviewing the audit plan, and accounting standards. Audit committee asking the auditors if there will be chairs oversaw implementation of a variety any significant changes to their of new accounting standards during the audit approach for the year in light period covered by our 2020 inspections. New of new or revised accounting or accounting standards for revenue recognition, auditing standards. lease accounting, and where applicable, preparing for implementation of current Asking the auditors to provide expected credit losses (CECL), stood out as the audit committee early notice particularly challenging and time consuming and frequent updates when new for many audit committee chairs. standards are being implemented. Implementation of the critical audit matter (CAM) requirements by auditors, by contrast, Setting aside time for educational was generally viewed as smooth, with audit sessions or deep dives where committee chairs noting that dry runs and auditors can explain and answer other early preparation with their auditors led questions about how new audit to few surprises. These views were consistent requirements may impact the with what we have heard elsewhere from audit audit.

Requesting that auditors Accounting Estimates communicate their approach and Use of Specialists to auditing the implementation of new accounting standards The PCAOB’s new requirements related (that are coordinated with to auditing accounting estimates, management’s timelines) and including fair value measurements, and implementation of new auditing using the work of specialists took effect standards. for audits of fiscal years ending on or after December 15, 2020. Discussing with the auditors In our 2020 conversations with audit whether they assessed any possible committee chairs, however, we learned challenges or issues associated that over three-quarters had not yet with auditing the implementation discussed the new requirements in detail of new accounting standards or with their auditors. We encourage audit applying new auditing standards committees to review our resource for and, if so, how the auditors plan to them on this topic. address them.

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committees and others, as discussed in our interim analysis report: Evidence on the Initial Impact of Critical Audit Matter Requirements. Audit Committee Many audit committee chairs were surprised Perspectives: What’s to learn the PCAOB is studying the economic impact of the CAM requirements. To increase Working Well awareness of the role and use of economic Regularly discussing with the auditors analysis in standard setting, including how how they and their firms are thinking we conduct economic analysis and gather through challenges, risks, and stakeholder input both before and after our opportunities associated with use of standards take effect, we published a new emerging technologies. resource, The PCAOB’s Use of Economic Analysis and Stakeholder Input in Standard Asking the auditors if/how the use of Setting, providing a high-level overview of technology will change the way the our process, as well as a “case study” on how team’s time and/or resources will be economic analysis has informed the adoption allocated. and implementation of the CAM requirements. As new technologies are implemented, discussing with EMERGING management if/how the underlying TECHNOLOGY controls will change and discussing with the auditors how they will The final area we addressed in our conversations evaluate and test any changes to the was emerging technologies and their use in the new controls. audit. Many audit committee chairs cited the Holding committee or full board potential benefits from the use of emerging deep dives on specific topics related technologies, notably to improve both the to emerging technologies, new audit and overall financial reporting quality. technology tools used in the audit, Specifically, they shared their belief that the and cybersecurity. use of data analytics, workflow automation, cloud computing, and other tools will allow Asking the auditor to provide best auditors to reduce manual work, obtain better practices or benchmarks for the use evidence, and become more efficient. Other of technology and/or information audit committee chairs noted that technology, security within the issuer’s industry. if deployed properly, can (1) cut down on opportunities to manipulate or falsify financial Discussing whether the company uses information and (2) provide auditors with the third-party software or data processing ability to more easily identify anomalies. for financial reporting processes and, if so, how risks and controls are Yet audit committee chairs also discussed considered and addressed. numerous challenges associated with emerging technologies. For example, several audit Asking the auditors for their views on committee chairs highlighted the gap between expertise or tools related to emerging the technological capabilities of the company technology, data protection, or and those of the audit firm. While some audit cybersecurity that may supplement management’s existing expertise or committee chairs noted that their companies tools. had more sophisticated technology than their

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auditors, others said the opposite. Either way, audit committee chairs largely agreed that companies and auditors need similar levels of We Want to Hear technological capabilities for the benefits of from You using emerging technologies to be fully realized. The PCAOB strives to improve our external Audit committee chairs were also wary of the communications and provide information risks that come with emerging technologies. that is timely, relevant, and accessible. They commonly flagged cybersecurity risk We invite you share your views on this as the thing that keeps them up at night, document by filling outour survey, which especially with the shift to remote work during should take no more than two minutes to the COVID-19 pandemic. Another risk cited complete. was overreliance on technology leading to less attention to or emphasis on preparer and auditor judgment, experience, or professional skepticism.

Additionally, some audit committee chairs voiced concerns about how: (1) the issuer maintains robust controls and makes necessary adjustments, (2) the auditor evaluates and tests changes to new controls, and (3) the audit firm implements internal controls over its technology. Some believed that companies and auditors alike should think about ways to increase training and to adjust existing controls or develop new controls.

Finally, audit committee chairs expressed concerns about technology unknowns, given that many technologies have only recently been adopted or put into use. They noted that while the benefits of emerging technologies are often immediately clear, the risks involved can take longer to become apparent or to understand.

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