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State Board Report

May 2014

Members of the Public Company Accounting Oversight Board seem to disagree over how reporting errors are described. The PCAOB’s use of the term “audit failures” in its inspection findings reports was questioned by PCAOB Board Member Jay D. Hanson in an address to the Pharma/Biotech Accounting & Reporting Congress on March 18. He pointed out that the way the PCAOB uses the term does not mean that the company’s financial statements were misstated, as it does when the U.S. Government Accountability Office uses it in its mandated studies. However, PCAOB Chairman James Doty told a conference at Baruch College on May 1 that he believes the public understands how the term is being used.

Mr. Hanson said: “I don’t believe it is necessary or appropriate for us to deviate from this more commonly understood definition of ‘audit failure’ by using that term to refer to our inspection findings – which are deficiencies in the firm’s work but not necessarily representative of problems in the audit client’s financial statements or internal controls. Therefore, I would like to see the Board eliminate the use of the term in our inspection reports (unless we know, with respect to a particular audit, that the auditor’s failure, in fact, relates to misstated financial statements),” Mr. Hanson stated.

The PCAOB’s inspections have changed things, Mr. Doty explained: “Before the audit inspection regime established by the Sarbanes-Oxley Act, an ‘audit failure’ could only be discovered if there were a restatement or other problem in the financial statements. Independent audit oversight and inspections, however, have allowed for new, independent insight into the performance of all audits. In that environment, it is both appropriate and useful to distinguish between a financial reporting failure and an audit failure. In my view, most people can, in this new environment, understand that distinction.”

A concept release on audit quality indicators that could be used to evaluate the quality of the audit firm’s work is expected to be opened for comment by the PCAOB in the coming months.

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