© grant thornton llp. all rights reserved. presentation to the chinese institute of certified...

© Grant Thornton LLP. All rights reserved.

Presentation to the Chinese Institute of Certified Public Accountants

10 April 2008

April MackenzieGrant Thornton International

© Grant Thornton LLP. All rights reserved. 2

Today's Agenda

• external quality control– overview of two oversight entities

• Public Company Accounting Oversight Board (PCAOB) – United States

• Financial Reporting Council (FRC) – United Kingdom

• internal quality control: ISQC 1• policy goals for the accounting profession


Topic 1: external quality controls

• Public Company Accounting Oversight Board (PCAOB) – U.S.

• Financial Reporting Council (FRC) – U.K.


United States: two primary national regulators


Public Company Accounting Oversight Board (PCAOB)

• established by the Sarbanes-Oxley Act of 2002 (SOX).• overseen by the U.S. Securities and Exchange Commission

(SEC).• anon-profit corporation – not a U.S. government agency or

establishment.• board consists of 5 full-time members:

– Only 2 members may have been CPAs.– All Board members must be independent.

• PCAOB may issue rules regarding registration, inspection, standards, enforcement.

• funded by "accounting support fees" levied on public companies, based upon size of such companies.


PCAOB – main functions

• registration: SOX and PCAOB rules require registration of public accounting firms that perform audit for public companies.

• inspection: PCAOB must inspect firms that audit public companies.

• standard setting: issues standards relating to auditing, quality control, ethics, independence.

• enforcement: conducts investigations and disciplinary proceedings and imposes appropriate sanctions on firms and individuals.


PCAOB – publicly-stated goals

• promote investor confidence in audited financial statements of public companies through use of supervisory method of firm oversight.

• inform, educate and obtain feedback from audit profession, market participants and others about the PCAOB's oversight activities and auditing best practices.

• strengthen the effectiveness and coordination of auditor oversight efforts in the U.S. and abroad.

• operate the PCOAB in a manner that recognizes its public mission.


PCAOB registration – requirements

• U.S. accounting firms must register: public accounting firms that are not registered with the PCAOB cannot prepare or issue audit reports, on participate in audits, of U.S. public companies.

• non-U.S. accounting firms must also register: any non-U.S. accounting firm that prepares or furnishes an audit report for any U.S. public company is subject to PCAOB's rules to the same extent as a U.S. accounting firm.

• must register even if firm does not prepare, issue or furnish the report: rule 2100 requires registration if the firm "plays a substantial role in the preparation or furnishing of an audit report with respect to any issuer."


PCAOB registration – facts ** Numbers based on 2006 annual report (2007 annual report has not yet been published)

• total number of registered firms at 2006 year end: 1,738. Since increased to 1843 as of 27 March 2008.

• foreign firm registration: 752 foreign firms at 2006 year end (or 43% of total firms).

• small firm registration: 537 firms (31%) reported 1-5 audit clients, and 976 firms (56%) reported no audit clients.

• countries with most PCAOB registered firms: U.S. (986); China (68); U.K. (64); Canada (54); Australia (36) and India (36).


PCAOB inspections – requirements

• all registered firms subject to inspection: all registered public accounting firms – including foreign firms – are subject to regular and special inspections in order to assess the degree of compliance of each firm with SOX, PCAOB rules, SEC rules, and professional standards.

• larger firms: inspections shall be annually for firms that issue audit reports for more than 100 issuers per year.

• smaller firms: inspections shall be at least once in every three years for firms that issue audit reports for between 1 and 100 issuers, or that play a substantial role in the preparation or furnishing of an audit report with respect to at least one issuer.

• inspection reports: PCAOB issues inspection reports.– portions of the report that deal with criticisms of, or potential defects

in, the firm's quality control systems are not made public if the firm satisfactorily addresses those matters within 1 year.

– part of report is made public.


PCAOB inspections – facts** Numbers based on 2006 annual report (2007 annual report has not yet been published)

• inspected 172 registered firms in 2006.• of these firms, 9 audited more than 100 public companies

(the 8 largest U.S. firms, and one Canadian firm).• other firms inspected include: 149 U.S. firms, and 14 non-

U.S. firms located in 7 different countries (all of which audited less than 100 public companies).

• reviewed portions of over 360 audits by largest 9 firms, and over 720 audits performed by 163 smaller firms.

• inspectors are experienced: team leaders of large firm inspections had average of 25 years relevant experience, and all other members had more than 14 years experience.


PCAOB inspections – reliance on foreign auditor oversight entities

• rule 4012: The PCAOB may rely on foreign oversight entities for inspection.

• PCAOB lists five critical principles of any auditor oversight system:– adequacy and integrity of the system;– the independence of the system's operation from the

auditing profession;– the nature of the system's source of funding;– the transparency of the system; and – the system's historical performance.


PCAOB inspections – reliance on foreign auditor oversight entities (cont'd)

• duplicative inspections – by PCAOB and home country oversight entity – can lead to duplicative and possibly inconsistent regulation.

• consequently, PCAOB recently issued exposure draft regarding "full reliance" on foreign auditor oversight bodies (i.e., no inspection by PCAOB).

• listed 25 "essential criteria" (under the five key principles) that the PCAOB would consider in determining whether it could place full reliance on a foreign auditor oversight body.

• good first step, but more recognition of foreign auditor oversight bodies is required.



• Grant Thornton International issued comment letter to PCAOB.• main Grant Thornton issues included:

– definition of "full reliance" did not really describe full reliance. – listing of "essential criteria" would create a check-the-box

approach that would improperly use the U.S. system as a benchmark.

• other jurisdictions can make different choices that are no less effective.

• other jurisdictions have different capital markets that may require different structures for auditor oversight entities.

– standard is not risk based, and does not discuss how the PCAOB would prioritize among jurisdictions.



• other Grant Thornton comments to PCAOB include:– PCAOB should not require full-time staff; rather, should merely

require access to sufficiently-qualified inspectors.– knowledge of U.S. GAAP/GAAS is unnecessary if foreign

registrants use IFRS audited under ISAs.– management of oversight entity should include a majority (as

opposed to entirely) of non-practicing auditors.– PCAOB's desire to access inspection and other reports of foreign

oversight entities may not be permitted by certain jurisdictions.– PCAOB should focus on whether the foreign oversight entity has

the ability to investigate.– PCAOB should be careful about requiring foreign oversight entities

to impose "appropriate" sanctions for violations; different countries may have different philosophies about sanctions and it is not for the PCAOB to determine what sanctions are appropriate.


United Kingdom: two regulators


FRC: organization and primary responsibilities

Financial Reporting Council

UK standard settersAPBASB

Financial Reporting

Review Panel

Professional Oversight Body

Accountancy and Actuarial

Discipline Board


Background to the UK's Professional Oversight Board (POB)

• formed in 2003 as an independent regulatory body of the auditing profession; previously the audit profession had been self-regulating.

• since 2006, the POB has responsibility for oversight of both the accountancy and actuarial professions.

• inspections of audit firms are carried out by the Audit Inspection Unit (AIU), as a subsidiary body of the POB.

• the board of the POB has 12 members.


The Audit Inspection Unit (AIU)

• director, a technical and quality control manager, and approximately 16 full time inspectors.

• proposed 2008/9 budget £2.7m (2007/8 £2.2m).• AIU will agree amendments with audit firms to

procedures where appropriate, and make recommendations for appropriate regulatory action.


Outline of the AIU's inspection methodology

• audit quality;• reviews of firm-wide procedures, including culture

of the firm;• risk based assessment of individual audits for

review;• assignment reviews;• assessment of communication with audit

committees.


AIU and reporting

• reports to the firm on individual assignments;• formal private report, summarising results of

assignment reviews and firm-wide procedures, to the audit registration committee;

• the firm is given the opportunity to comment on draft reports;

• public reports have previously been issued on the profession as a whole, on a no-names basis;

• public reports on the firm, and assignment reports to be shared with the audit committee, from 2008.


Topic 2: internal quality control – International Standard on Quality Control (ISQC) 1

• promulgated by the IAASB.• ISQC 1 establishes standards and provides guidance

regarding a firm's responsibilities for its system of quality control for audits and reviews of historical financial information, and for other assurance and related services engagements.

• such system should be designed to provide a firm with reasonable assurance that the firm and its personnel comply with professional standards and regulatory and legal requirements, and that reports issued by the firm or engagement partners are appropriate in the circumstances.


ISQC 1

• applies to all firms.• nature of the policies and procedures developed

by individual firms to comply with ISQC 1 will depend on various factors such as the size and operating characteristics of the firm, and whether it is part of a network.

• effective date: 15 June 2006.


ISQC 1: quality control policies and procedures

• quality control policies and procedures should be documented and communicated to the firm’s personnel. – this includes the message that each individual has a

personal responsibility for quality and is expected to comply with these policies and procedures.

• feedback on firm’s quality control system from its personnel is important, – therefore, personnel are encouraged to communicate

their views or concerns on quality control matters.


ISQC 1: elements of a system of quality control – leadership

• firm's system of quality control should include policies and procedures addressing each of the following six elements: – leadership responsibilities for quality within the firm.

• CEO or managing board must assume ultimate responsibility for quality control.

• firm leadership must recognize that firm's business strategy is subject to overriding requirement for firm to achieve quality.

• person assigned responsibility for quality control by the CEO must have sufficient expertise, ability and authority.


ISQC 1: elements of a system of quality control – ethics

– ethical requirements, including independence (as set forth in the IFAC Code of Ethics).

• code establishes the following fundamental principles of ethics: – integrity;– objectivity;– professional competence and due care;– confidentiality; and – professional behavior.

• firm's policies and procedures should enable firm to:– communicate independence requirements to its personnel;– identify and evaluate threats to independence.


ISQC 1: elements of a system of quality control – client relationship and human resources

– acceptance and continuance of client relationships/specific engagements, and policies must ensure that:

• firm consider client's integrity;• firm is competent to perform the engagement; and • firm can comply with ethical restrictions.

– human resources, including policies designed to provide firm with reasonable assurance that it has sufficient personnel with proper capabilities to perform engagements.

• policies and procedures should address: recruitment; performance evaluation; capabilities; competence; career development; promotion; compensation; and estimation of personnel needs.


ISQC 1: elements of a system of quality control – engagement performance

– engagement performance, specifically procedures designed to provide firm with assurance that engagements are performed in accordance with professionals standards and laws, including policies and procedures that:

• ensure that appropriate consultation occurs on difficult matters;

• deal with and resolve differences of opinion on the engagement team; and

• require an engagement quality control review, which provides an objective evaluation of significant judgments made by the engagement team.


ISQC 1: elements of a system of quality control -- monitoring

– monitoring• the firm should establish policies and procedures

designed to provide it with reasonable assurance that the policies and procedures relating to the system of quality control are relevant, adequate, operating effectively and complied with in practice.

• such policies and procedures should include an ongoing consideration and evaluation of the firm’s system of quality control, including a periodic inspection of a selection of completed engagements.


Monitoring – practical tip

• should take place as early as possible after the busy season to enable timely:– communication of the issues to engagement

teams, training leaders, firm's management board;

– recommendations;– corrective actions;– disciplinary sanctions; and– training.


Topic 3: Public policy – goals for the accounting profession

• two important policy goals for the accounting profession:– global adoption of international standards.

• accounting;• auditing;• ethics/independence.

– regulatory convergence.


Policy goals for the accounting profession (cont'd)

• reason for these goals: to improve the reliability and relevance of financial reporting and auditing.– improve capital market efficiencies.– enhance the quality of audits in various regions.– reduce audit costs.


Goal #1: Global adoption of international standards

• global sets of standards that countries should adopt:– International Financial Reporting Standards

(IFRS)– International Standards of Auditing (ISAs)


International Financial Reporting Standards (IFRS)

• most countries are moving toward a single set of financial reporting standards: IFRS, which are promulgated by the IASB.

• U.S. is moving in that direction.– specifically, the U.S. SEC just agreed to eliminate the

reconciliation requirement to U.S. GAAP for foreign private issuers reporting in IFRS.

– further, the SEC issued a concept release that explores allowing U.S. issuers to report under IFRS.

• important to reduce/eliminate country variation on IFRS – goal is one financial reporting standard, not many standards.


International Standards on Auditing (ISAs)

• ISAs are published by the International Auditing and Assurance Standards Board (IAASB).

• like financial reporting standards, important to move to one set of auditing standards.

• reduce costs, reduce complexity, increase efficiencies – all of which benefit the capital markets.


Forum of Firms requirements

• maintain appropriate quality control standards in accordance with ISQC 1, in addition to relevant national quality control standards; and conduct, to the extent not prohibited by national regulation, regular globally coordinated internal quality assurance reviews.

• have policies and methodologies for the conduct of audits that are based, to the extent practicable, on ISAs issued by the IAASB.

• have policies and methodologies which conform to the IFAC Code of Ethics for Professional Accountants and national codes of ethics.


Goal #2: Regulatory convergence

• this is closely related to adoption of global standards.• convergence of regulatory regimes is necessary because

adoption of global standards will be of limited use if standards are applied differently in different countries.

• conflicting regulatory regimes impede the auditing firms' ability to deliver quality services to clients on a global basis.

• conversely, alignment of regulatory regimes could eliminate or minimize the barriers that work against the firms' goal of achieving consistently high levels of audit quality.


Examples: adoption of international standards and regulatory convergence

• examples:– International Federation of Accountants (IFAC)

Code of Ethics. – U.S. PCAOB proposal regarding full reliance on

non-U.S. oversight entities (discussed previously).

– U.S. SEC mutual recognition initiative.– EC efforts on mutual recognition.– CESR efforts on GAAP equivalence.


IFAC Code of Ethics

• IFAC is the worldwide organization for the accountancy profession. There are a number of standard-setting boards that operate under the auspices of IFAC.

• standard setting boards of IFAC are subject to independent oversight and transparent due process

• one of these boards, the International Ethics Standards Board for Accountants (IESBA), has published a comprehensive code of ethics designed to govern the behavior of auditors.

• code addresses issues such as auditor independence, permissible non-audit services, conflicts of interest.

• important to capital markets: dissimilar rules – particularly with respect to independence – can disqualify auditors even if an independence violation is de minimis and occurs at a small subsidiary.


SEC initiatives on mutual recognition

• in March, the U.S. SEC announced a series of actions it intends to take to further the implementation of the concept of mutual recognition for high-quality regulatory regimes in other countries. In particular, the SEC contemplates taking the following actions:– exploring agreements with foreign regulators, based upon a

comparability assessment by the SEC and by the foreign authority of one another's regulatory regimes.

– considering adoption of a formal process for engaging other national regulators on the subject of mutual recognition.

– developing a framework for mutual recognition discussions with jurisdictions comprising multiple securities regulators tied together by a common legal framework, including the European Union (whose national securities regulators are subject to supranational legislation and directives).


European Commission Efforts on Mutual Recognition

• EC paper: “Draft Commission Decision concerning a transitional period for audit activities of certain third country auditors and audit entities.”

• Draft transitional provisions allow third country auditors to continue their audits until at least 2012, provided that the auditor provides the following information to the “competent authority” in the Member State of that market: – name and address of auditor and legal structure; – a description of the audit network; – the auditing standards and independence requirement applied to

the audit; – a description of the internal quality control system of the auditor;

and – the date when the last quality assurance review of the auditor was

carried out and the outcome thereof.


CESR advice on GAAP equivalence

• on 31 March, the Committee of European Securities Regulators (CESR) published its advice to the European Commission on the equivalence of Chinese, Japanese and US GAAPs.

• CESR’s recommendations in the technical advice are the following: – that the EC find US GAAP equivalent to IFRS for use on EU markets. – that the EC consider Japanese GAAP equivalent, unless there is no

adequate evidence of the Accounting Standards Board of Japan (ASBJ) achieving to timetable the objectives set out in the Tokyo Agreement.

– that the EC postpone a final decision on Chinese GAAP until there is more information on the application of the new Chinese accounting standards by Chinese issuers.

• CESR noted that the first complete reporting period under the new Chinese standards will only be for 2007 accounting periods.

• Thus, as yet no evidence available concerning the concrete implementation of the standards by companies and auditors.

• CESR believes that evidence of adequate implementation is important.

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