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Notice of Filing of Proposed Rules on Auditing Accounting Estimates, Including Fair Value Measurements, and Amendments to PCAOB Auditing Standards

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Notice of Filing of Proposed Rules on Auditing Accounting Estimates, Including Fair Value Measurements, and Amendments to PCAOB Auditing Standards SECURITIES AND EXCHANGE COMMISSION (Release No. 34-85434; File No. PCAOB-2019-02) March 28, 2019 Public Company Accounting Oversight Board; Notice of Filing of Proposed Rules on Auditing Accounting Estimates, Including Fair Value Measurements, and Amendments to PCAOB Auditing Standards Pursuant to Section 107(b) of the Sarbanes-Oxley Act of 2002 (the "Act" or "Sarbanes-Oxley Act"), notice is hereby given that on March 20, 2019, the Public Company Accounting Oversight Board (the "Board" or "PCAOB") filed with the Securities and Exchange Commission (the "Commission" or "SEC") the proposed rules described in Items I and II below, which items have been prepared by the Board. The Commission is publishing this notice to solicit comments on the proposed rules from interested persons. I. Board's Statement of the Terms of Substance of the Proposed Rules On December 20, 2018, the Board adopted a new rule and amendments to auditing standards (collectively, the "proposed rules"), under which the three existing standards related to auditing estimates, including fair value measurements, will be replaced with a single, updated standard. The text of the proposed rules appears in Exhibit A to the SEC Filing Form 19b-4 and is available on the Board’s website at https://pcaobus.org/Rulemaking/Pages/docket-043-auditing-accounting-estimates-fair- value-measurements.aspx and at the Commission’s Public Reference Room. II. Board's Statement of the Purpose of, and Statutory Basis for, the Proposed Rules In its filing with the Commission, the Board included statements concerning the purpose of, and basis for, the proposed rules and discussed any comments it received on 1 the proposed rules. The text of these statements may be examined at the places specified in Item IV below. The Board has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. In addition, the Board is requesting that, pursuant to Section 103(a)(3)(C) of the Sarbanes-Oxley Act, the Commission approve the proposed rules for application to audits of emerging growth companies ("EGCs").1 The Board's request is set forth in section D. A. Board's Statement of the Purpose of, and Statutory Basis for, the Proposed Rules (a) Purpose Summary The Board has adopted amendments to its standards for auditing accounting estimates and fair value measurements, under which three existing standards will be replaced with a single, updated standard ("AS 2501 (Revised)" or the "new standard"). As discussed in more detail below, in the Board's view, the new standard and related amendments will further investor protection by strengthening audit requirements, applying a more uniform, risk-based approach to an area of the audit that is of increasing prevalence and significance, and updating the standards in light of recent developments. The financial statements of most companies reflect amounts in accounts and disclosures that require estimation, which may include fair value measurements or other types of estimates. These estimates appear in items like revenues from contracts with customers, valuations of certain financial and non-financial assets, impairments of long- 1 The term "emerging growth company" is defined in Section 3(a)(80) of the Securities Exchange Act of 1934 (the "Exchange Act") (15 U.S.C. 78c(a)(80)). See also Inflation Adjustments and Other Technical Amendments Under Titles I and III of the JOBS Act, Release No. 33-10332 (Mar. 31, 2017), 82 FR 17545 (Apr. 12, 2017). 2 lived assets, allowances for credit losses, and contingent liabilities. As financial reporting frameworks evolve toward greater use of estimates, accounting estimates are becoming more prevalent and more significant, often having a significant impact on a company's reported financial position and results of operations. By their nature, accounting estimates, including fair value measurements, generally involve subjective assumptions and measurement uncertainty, making them susceptible to management bias. Some estimates involve complex processes and methods. As a result, accounting estimates are often some of the areas of greatest risk in an audit, requiring additional audit attention and appropriate application of professional skepticism. The challenges of auditing estimates may be compounded by cognitive bias, which could lead auditors to anchor on management's estimates and inappropriately weight confirmatory over contradictory evidence. The Board's oversight activities, which have revealed a recurring pattern of deficiencies in this area, also raise concerns about auditors' application of professional skepticism, including addressing potential management bias, in this area of the audit. Over the years, PCAOB staff has provided guidance for auditors related to auditing accounting estimates, but this area remains challenging and practices among firms vary. Currently, three PCAOB auditing standards primarily relate to accounting estimates, including fair value measurements. These three standards, which were originally adopted between 1988 and 2003, include common approaches for substantive testing but vary in the level of detail in describing the auditor's responsibilities with respect to those approaches. In addition, because the three standards predate the Board's risk assessment standards, they do not fully integrate risk assessment requirements that 3 relate to identifying, assessing, and responding to the risks of material misstatement in accounting estimates. The new standard builds on the common approaches in the three existing standards and will strengthen PCAOB auditing standards in the following respects: • Providing direction to prompt auditors to devote greater attention to addressing potential management bias in accounting estimates, as part of applying professional skepticism. • Extending certain key requirements in the existing standard on auditing fair value measurements, the newest and most comprehensive of the three existing standards, to other accounting estimates in significant accounts and disclosures, reflecting a more uniform approach to substantive testing for estimates. • More explicitly integrating requirements with the Board's risk assessment standards to focus auditors on estimates with greater risk of material misstatement. • Making other updates to the requirements for auditing accounting estimates to provide additional clarity and specificity. • Providing a special topics appendix to address certain aspects unique to auditing fair values of financial instruments, including the use of pricing information from third parties such as pricing services and brokers or dealers. The Board has adopted the new standard and related amendments after substantial outreach, including two rounds of public comment. Commenters generally supported the 4 Board's objective of improving the quality of audits involving accounting estimates, and suggested areas where the proposed requirements could be modified or clarified. The Board has taken all of these comments, as well as observations from PCAOB oversight activities and the relevant academic literature, into account. In a separate PCAOB release, the Board also adopted amendments to its standards for using the work of specialists, which are often involved in developing, or assisting in the evaluation of, accounting estimates.2 Certain provisions of the new standard include references to AS 1210, Using the Work of an Auditor-Engaged Specialist; AS 1201, Supervision of the Audit Engagement; and AS 1105, Audit Evidence, as amended. In its consideration of the new standard and related amendments, the Board is mindful of the significant advances in technology that have occurred in recent years, including increased use of data analysis tools and emerging technologies. An increased use of technology-based tools, together with future developments in the use of data and technology, could have a fundamental impact on the audit process. The Board is actively exploring these potential impacts through ongoing staff research and outreach. In the context of this rulemaking, the Board considered how changes in technology could affect the processes companies use to develop accounting estimates, including fair value measurements, and the tools and techniques auditors apply to audit them. The Board believes that the new standard and related amendments are sufficiently principles-based and flexible to accommodate continued advances in the use of data and technology by both companies and auditors. The Board will continue to monitor 2 See Amendments to Auditing Standards for Auditor's Use of the Work of Specialists, PCAOB Release No. 2018-006 (Dec. 20, 2018) ("Specialists Release"). 5 advances in this area and any effect they may have on the application of the new standard. The new standard and related amendments apply to all audits conducted under PCAOB standards. Subject to approval by the Commission, the new standard and related amendments will take effect for audits for fiscal years ending on or after December 15, 2020. (b) Statutory Basis The statutory basis for the proposed rules is Title I of the Act. B. Board's Statement on Burden on Competition Not applicable. The Board’s consideration of the economic impacts of the proposed rules is discussed in section D below. C. Board's Statement on Comments on the Proposed Rules Received from Members, Participants or Others The Board released the proposed rules for public comment in Proposed Auditing Standard—Auditing Accounting Estimates, Including Fair Value Measurements, and Proposed
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