November 2000

Report of the POB Panel on Audit Effectiveness: Changes in the Final Report

By Gerald Smith

In the interim between the release of the exposure draft (ED) of the POB Panel on Audit Effectiveness report in May and the issuance of its final report in August, the panel conducted a public hearing to obtain views from constituents about the ED.

The public hearing began with a presentation by SEC Chair Arthur Levitt, followed by presentations and testimony given by representatives of domestic and international professional organizations, the Big Five, and NASBA. In addition, representatives of four state boards of accountancy and the academic community presented and discussed their reactions to the ED. Separately, the panel received and considered 42 comment letters about the ED. After analyzing all of the input, the panel deliberated again and a number of changes resulted.

Several commentators had observed that not all of the recommendations appeared to flow from the quasi-peer reviews. In the final report, the panel clarified that its recommendations arose from a variety of sources and, rather than being limited to suggestions that could remedy perceived deficiencies, were intended to facilitate the use of identified best practices. Because the ED called for more definitive standards, some commentators wondered if the panel’s intention was to increase auditors’ use of checklists and decrease reliance on professional judgment. In the final report, the panel explained that it was suggesting the development of better guidance to assist auditors in exercising professional judgment; it was not advocating additional checklists.

The final report expands the ED’s recommendations to the Auditing Standards Board (ASB) to include the following:

This last recommendation creates the most potential for conflict. Although decreased autonomy will not be easy for the ASB to accept, the panel believes this is essential if its recommendations are to receive serious consideration from the auditing profession.

Many commentators requested that the panel either drop or defer its recommendation for a “forensic-type phase” in all audits. After considering the input, however, the panel continues to believe that all audits must include a substantial forensic-type phase. The panel clarified that all quasi-peer reviews were subjected to a “Consideration of Fraud in a Financial Statement Audit” (SAS No. 82) evaluation and that the “zero-defects” goal was not intended to imply that there never would be an undetected material financial fraud, because “reasonable assurance” rather than “absolute assurance” is the auditors’ standard of responsibility. The panel also acknowledged that a goal of zero defects does not imply that, if an auditor fails to detect a material financial statement fraud, it indicates GAAS noncompliance. Audit committees are encouraged to obtain written acknowledgment from management that the audit committee has the primary responsibility for preventing and detecting fraud.

The ED called for strengthened standards effective for audits of financial statements for the period ending December 31, 2001. The final report additionally extends this timetable to December 31, 2002.

The principal change between the ED and the final report regarding audit firms is an added discussion regarding collegiate education. The panel recognizes that its recommendations increase the knowledge and skills necessary to be an auditor. These can be brought to the firms by newly hired personnel or acquired through CPE or on-the-job training. Because of concerns over the decline in the number of entry-level accountants, the Big Five, the American Accounting Association (AAA), the AICPA, and the Institute of Management Accountants (IMA) sponsored a project to evaluate the current accounting education environment. The monograph that resulted from this project, Accounting Education: Charting the Course Through a Perilous Future, by W. Steve Albrecht and Robert J. Sack, was discussed and distributed at the AAA’s annual meeting in August. The panel believes the evaluation of accounting education is crucial in addressing the challenge of attracting future audit professionals.

The panel’s final report updates the auditor independence chapter of the ED to include the SEC’s proposed rulemaking on auditor independence. The panel, having found it impossible to reach consensus on whether to recommend adoption of an exclusionary ban on nonaudit services, includes in the final report both a section that supports such an exclusionary ban and a statement that opposes such a ban. Both the ED and the final report clearly state the pros and cons of both positions.

In the final report, the panel recommended that the POB, SEC, AICPA, SECPS, and major firms promptly agree to a charter for the POB. In late August, two items reportedly remained under negotiation: the POB’s role in the appointment of the ASB chair, as well as the SECPS executive committee chair, and the procedures to amend the POB charter. The panel thinks that agreement on a charter will be a major step forward in the governance of the auditing profession.

In the final report, the panel also expanded its recommendation regarding POB oversight of the profession. The final report recommends subjecting the standards-setting activities of the AICPA’s Professional Ethics Executive Committee that relate to audits of public companies to POB oversight. The panel also recommended that the POB and the state boards of accountancy explore how communication can be facilitated among them.

In the international arena, the final report recommended to FASB that an international accounting standard address the subject of going concern that could, furthermore, be referenced by international auditing standards. The panel recognized that achieving true transparency requires cooperative efforts on the part of everyone involved in financial reporting and raising capital. The final report added a recommendation encouraging a formal cooperative effort between the ASB and the International Auditing Practices Committee (IAPC) aimed at harmonizing global auditing standards.

In the report’s concluding chapter, “Looking Ahead,” the panel acknowledged technology’s impact on information systems and the potential for possible changes to the current accounting model. New audit approaches will be required to meet the demands for new information; the willingness to adapt to changes in the accounting model will be essential.

The final report concluded, as did the ED, by acknowledging that the POB should not hesitate to call for “further reviews if circumstances demonstrate the need to do so,” because “[a]t the end of the day, the public interest is paramount.”

Gerald Smith, PhD, CPA, is a professor and chair of the accounting department at the University of Northern Iowa, Cedar Falls.

Editor’s Note: The final report is available online at A single copy of the final report can be obtained by sending a written request to:

Panel on Audit Effectiveness
c/o The Public Oversight Board
One Station Place
Stamford CT 06902

Thomas W. Morris

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