The Public Company Accounting Oversight Board voted unanimously Tuesday to propose for public comment a new standard for audit confirmations, replacing an interim standard that hasn't changed for two decades.
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"The auditor's use of confirmation has been a required audit procedure in the United States that dates back to 1939, when the American Institute of Accountants adopted Statement on Auditing Procedure No. 1 as a direct response to the McKesson & Robbins fraud case, which involved fraudulently reported inventories and accounts receivable that the independent auditors failed to detect through procedures other than confirmation," said PCAOB chair Erica Williams during prepared remarks Tuesday at an webcast meeting of the board. "Since then, independently obtained third-party information continues to be an important source of evidence obtained as part of an audit of a company's financial statements. The world has evolved since AS 2310 was adopted by the board, and today we are taking an important step toward making sure our confirmation standard keeps up and keeps investors protected."
The confirmation process involves an auditor sending a confirmation request directly to a confirming party such as a bank, evaluating the elicited information, and addressing nonresponses and incomplete responses to gather audit evidence about one or more financial statement assertions. Confirmation can be a crucial part of the evidence that auditors get to support their opinion on a company's financial statements. A properly designed and performed confirmation can also be an important way for auditors to deal with fraud risks.
"Evidence obtained by the auditor from a knowledgeable third-party source outside the company generally is more reliable than evidence obtained only from internal company sources, and confirmations have long been used on nearly every audit," said PCAOB board member Duane DesParte. "A well-designed and well-executed confirmation process can be an effective and efficient way to validate various financial statement assertions — such as completeness, existence, or obligations. Confirmations can also be useful in validating terms of significant transactions, identifying related parties and addressing risk of misstatement from fraud. Today's proposal serves to modernize our 'interim' confirmation standard adopted by the board in 2003 to account for changes in the business environment since then, including the electronic transmission of confirmation requests and responses and the use of technology and third-party intermediaries to facilitate the confirmation process."
Recent accounting fraud cases have pointed to the need to update the old standards, including one in Germany that impacted Big Four auditing firms. "When a company suddenly implodes, many of us are often stunned to learn that basic audit procedures, including obtaining independent third-party evidence through confirmation, were not used," said PCAOB board member Kara Stein, a former commissioner at the Securities and Exchange Commission. "The Wirecard case in Germany is a good example. We are learning from the ongoing criminal trial that the alleged fraud — the country's largest ever — involved vast amounts of fake revenues, a complex web of transactions routed through a variety of shell companies, and a false picture of financial strength and liquidity. The fraud unraveled when the company defaulted on bond payments even though it had more than adequate cash on its balance sheet. Where was this online payment processor's $2 billion in cash located (25% of the balance sheet)? Company management said the cash was in two banks in the Philippines, and this was supported by the company's records and internal documents. But no one asked the banks. Let me just say that again: No one, including the company's independent auditor for many years, asked the banks."
The proposed standard expands the existing standard to include electronic confirmations, noted PCAOB board member Christina Ho, who is chairing the PCAOB's new Technology Innovation Alliance Working Group. "Confirmations are critical audit procedures to obtain audit evidence from third parties concerning the existence of cash and other significant accounts as well as to detect fraud," she said. "I am pleased that this proposal addresses some of the technological advances in auditing. As noted in our strategic plan, the PCAOB must continue to anticipate and respond to emerging trends impacting audit quality."
Detailed questions are included within the proposal, and the PCAOB is asking for comments on any or all topics, responses to any or all questions, feedback in areas not covered by specific questions, and any evidence that informs commenters' views.
"Given the increased risk of fraud in this current economic environment, I am particularly interested to see commenter views on whether the proposal strikes the right balance with respect to the auditor's consideration of confirmation procedures in response to significant risks arising from other kinds of transactions or arrangements with third parties," said PCAOB board member Anthony Thompson. "This proposal also requires communication to the audit committee in instances where the auditor has determined that the presumption to confirm accounts receivable has been overcome. Having audit committees aware of when the auditor determines to overcome that presumption strengthens their ability to perform their oversight role of the audit committee over auditor judgment. The confirmation process has evolved significantly with the use of electronic means of confirmation, and diligence is essential to ensure reliability of electronic confirmation responses and to combat undue reliance on technology. This proposal highlights that the quality of the audit evidence obtained through confirmation procedures regardless of the means provided is integral to the audit process."
