The staff of the Public Company Accounting Oversight Board has issued Spotlight: Inspection Observations Related to Auditor Independence (September 2024). The Spotlight highlights PCAOB inspection observations on independence and describes common deficiencies that resulted in the issuance of inspection comments. The Spotlight also discusses good practices and reminders for audit firm compliance with the SEC and PCAOB independence standards and rules. The report concludes with suggestions regarding audit committee oversight of auditor independence.
Inspection Observations Related To Independence
The Spotlight discusses eleven types of independence deficiencies that the PCAOB staff observed during the 2021-2023 inspection cycles. These eleven independence deficiency areas are:
Audit committee pre-approval of services/communication with the audit committee.
Independence representations/ personal independence compliance testing.
Prohibited financial relationships.
Permissibility of non-audit and tax services.
Business and employment relationships.
Indemnification clauses.
Independence policies.
Partner rotation.
Restricted entity list.
Contingent fees.
Mutual interest/unpaid fees.
For each deficiency area, the report presents the percentage of independence-related comment forms issued concerning the deficiency, summarizes the applicable SEC or PCAOB independence rule or standard, and provides inspection observations regarding the deficiency.
Issues in the first category, audit committee pre-approval of services and communication with the audit committee, were the most frequent source of independence-related inspection comments. In 2023, 43 percent of independence-related comments related to that issue. Inspection observations included:
The auditor was unable to provide the inspectors with evidence that audit committee pre-approval had occurred before the audit firm commenced audit, non-audit, and/or tax services (or that the pre-approval requirement had been waived).
Before its initial audit engagement, the auditor did not describe, in writing, to the potential audit client’s audit committee the scope of non-audit services it had provided that might reasonably be viewed as bearing on the audit firm’s independence.
The auditor did not describe, in writing, annually to the audit client’s audit committee non-audit services it provided that might reasonably be viewed as bearing on the audit firm’s independence. In some cases, the audit firm’s communication to the audit committee was inaccurate (e.g., did not include ownership and sale of shares of the audit client by an audit firm covered person).
Good Practices and Reminders For Auditors
The Spotlight describes some practices the inspection staff believes contribute to compliance with the independence requirements. These “good practices” include using technology-based tools to promote early detection of potential independence violations (e.g., frequent comparison of audit personnel time charges to financial holdings or automated access to audit personnel brokerage accounts to compare financial holdings and transactions to the firm’s restricted list). Other good practices include more frequent (e.g., quarterly) independence compliance representations from audit personnel and use of engagement letter templates for clients subject to SEC and PCAOB independence standards to avoid inadvertent use of indemnification clauses or contingent fees.
The Spotlight also includes a series of reminders for auditors regarding independence. These include reviewing the engagement letters of other auditors involved in a public company audit to make sure they do not contain prohibited terms, not presuming that an audit committee has or will approve or pre-approve services, and “continuous conversations” with audit clients about their plans, such as IPOs or acquisitions.
Audit Committee Considerations
The Spotlight notes that audit committees are responsible for the engagement and oversight of the company’s independent auditor and suggests some audit committee independence oversight considerations:
Audit committees are required to consider whether any services provided by the audit firm may impair the audit firm’s independence in advance.
Audit committees should be aware that certain financial relationships between the company and the independent auditor are prohibited.
Audit committees should consider whether the public company’s policies and procedures require that all audit and non-audit services be brought before the audit committee for pre-approval.
Audit committees should not approve engagements that remunerate an independent auditor on a contingent fee or a commission basis, as such remuneration is considered to impair the auditor’s independence.
Audit committees should consider whether their auditor has implemented processes to identify prohibited relationships.
Audit committees should discuss with the audit firm (1) Processes the audit firm uses to ensure complete disclosure of all relationships with the public company and its affiliates; and (2) Relationships the audit firm may have with officers, board members, and significant shareholders.
If the audit committee pre-approves services using pre-approval policies and procedures, the audit committee should consider whether the pre-approval policies and procedures are sufficiently detailed as to the services to be provided so that the audit committee can make a well-reasoned assessment of the impact of the service on the auditor’s independence.
Independence is a shared responsibility between the entity under audit, its audit committee, and its auditor. It is important for the company to have policies and procedures to proactively alert auditors to proposed or pending merger and acquisition activity that could have an impact on auditor independence.
Audit Committee Takeaways
Auditor independence is a perennial area of SEC and PCAOB focus. In the last several years, both the Commission and the Board have also stressed the importance of auditor-audit committee communications regarding independence and the audit committee’s responsibility to monitor the independence of the company’s auditor. See, e.g., PCAOB Files More Audit Committee Communications Cases in this Update, Acting Chief Accountant Speaks Out on Auditor Independence, June-July 2022 Update, and Acting Chief Accountant Stresses Auditor Independence and Audit Committee Oversight, November -December 2021 Update. Audit committees should review the PCAOB’s suggested audit committee independence oversight considerations and integrate them into their work.
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