PCAOB Report on Pandemic Auditing

The PCAOB just published a mid-pandemic progress report on how audit firms are handling their work during coronavirus. Compliance and audit executives may want to give it a read for hints about how auditors are trying to inspect your internal controls and which risks are high priority.

The report, Staff Observations and Reminders During the Covid-19 Pandemic, was published Wednesday morning. It’s based on PCAOB staff analysis of several dozen financial audits or interim financial statement reviews that audit firms performed earlier this year as the pandemic was in its first wave; plus analysis of guidance that audit firms gave to their employees about how to keep calm and carry on during such difficult circumstances. The whole thing is only 10 pages long, an easy read over breakfast or when you’ve turned off your camera during a Zoom call.

So what did the PCAOB find? Nothing too surprising, when you think about it.

First, audit teams have been talking more often with corporate audit committees, including during the auditors’ reviews of interim financial statements. (Talking with the audit committee in advance of the annual audit is to be expected; talking with the audit committee while reviewing quarterly reports, less so.) Those conversations have been about the potential effect of the pandemic on business operations and on the client company’s internal control over financial reporting.

Second, many audit teams have focused more of their procedures on the client company’s ability to continue as a going concern and on the potential impairment of goodwill or other long-lived assets. Neither of those things should be a surprise. Companies faced considerable liquidity risks earlier this year as we all entered the pandemic, which strained the ability to continue. Remaining in the pandemic, meanwhile, has depressed the value of some goodwill assets to the point of impairment.

Some audit teams, the PCAOB said, have brought specialists into the engagement to analyze high-risk areas such as certain accounting estimates (lookin’ at you, allowances for doubtful accounts) or projections for future financial performance. Some companies responded by bringing their own specialists to defend certain asset valuations. 

Inventory has been an especially tricky issue, because auditors can no longer just show up at an office or warehouse and start counting. Some audit firms have responded with “virtual inventory inspection,” where they use remote cameras or drones to inspect inventory. (Inventory inspection by drone has actually been around for a few years, but the pandemic has made it much more popular.)

It’s also interesting to see how audit teams are organizing their internal work to keep going through the pandemic. The PCAOB told of one team that held an all-day virtual meeting to simulate the experience of working together in the office. That sounds like actual hell to me, but hey, to each their own.

Pandemic From the Corporate Perspective 

Internal control professionals can use this report to deduce what auditors are more likely to inquire about when they show up at your business, based on the issues that the PCAOB is raising with those folks. (The SEC has also published observations about pandemic financial reporting issues, well worth reading.)

For example, the pandemic is forcing companies to make significant judgments and accounting estimates despite considerable uncertainty about the business climate. So as auditors review interim financial statements from one quarter to the next, they’re going to — or at least, they should — ask more probing questions about the assumptions behind those judgments and estimates management makes. (Goodwill valuations are a great example of this.) As the PCAOB report put it: “The auditor’s assessment of significant assumptions involves considering whether management considered relevant evidence, regardless of whether it corroborates or contradicts the public company’s assumption.”

You can anticipate that line of thinking from your auditors, and be ready with whatever documentation or other evidence might help to answer the auditors more quickly. 

The pandemic has also strained many companies’ internal control over financial reporting, either through employee furloughs or new ICFR procedures and technologies we all improvised earlier this spring when everyone started working from home. The PCAOB and the Securities & Exchange Commission both know this is a heightened risk; which means they’re telling audit firms to pay more attention to ICFR risks; which means you need to be ready for that heightened attention.

The PCAOB report offered two examples:

• Some ICFR changes might be temporary, others permanent. That might affect the auditor’s thinking on which controls to test and what procedures to perform. 
• Some ICFR controls might be performed more or less frequently than normal. Again, that might affect the auditor’s thinking on how to test the control’s effectiveness. 

Fraud risk, meanwhile, has gone haywire thanks to changed business circumstances, new operating procedures, new customers, employees’ personal pressures, and more. So auditors should always be thinking about the potential for fraud as they examine accounting estimates and ICFR and design procedures to test those items.

As I said at the start: none of this should be surprising if you think about it for a moment. So do think about it, and how your audit firm is likely to approach ICFR and financial audits — and then plan accordingly.