Document ID: SEC-2019-0398-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Public Company Accounting Oversight Board
Posted Date: 2019-04-04T04:00Z

[Federal Register Volume 84, Number 65 (Thursday, April 4, 2019)]
[Notices]
[Pages 13442-13484]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-06425]

[[Page 13441]]

Vol. 84

Thursday,

No. 65

April 4, 2019

Part III

Securities and Exchange Commission

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Public Company Accounting Oversight Board; Notice of Filing of Proposed 
Rules on Amendments to Auditing Standards for Auditor's Use of the Work 
of Specialists; Notice

  Federal Register / Vol. 84 , No. 65 / Thursday, April 4, 2019 / 
Notices  

[[Page 13442]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-85435; File No. PCAOB-2019-03]

Public Company Accounting Oversight Board; Notice of Filing of 
Proposed Rules on Amendments to Auditing Standards for Auditor's Use of 
the Work of Specialists

March 28, 2019.
    Pursuant to Section 107(b) of the Sarbanes-Oxley Act of 2002 (the 
``Act'' or ``Sarbanes-Oxley Act''), notice is hereby given that on 
March 20, 2019, the Public Company Accounting Oversight Board (the 
``Board'' or ``PCAOB'') filed with the Securities and Exchange 
Commission (the ``Commission'' or ``SEC'') the proposed rules described 
in Items I and II below, which items have been prepared by the Board. 
The Commission is publishing this notice to solicit comments on the 
proposed rules from interested persons.

I. Board's Statement of the Terms of Substance of the Proposed Rules

    On December 20, 2018, the Board adopted amendments to auditing 
standards for using the work of specialists (collectively, the 
``proposed rules''), including amendments to two existing auditing 
standards and the retitling and replacement of a third standard with an 
updated standard. The text of the proposed rules appears in Exhibit A 
to the SEC Filing Form 19b-4 and is available on the Board's website at 
https://pcaobus.org/Rulemaking/Pages/docket-044-auditors-use-work-specialists.aspx and at the Commission's Public Reference Room.

II. Board's Statement of the Purpose of, and Statutory Basis for, the 
Proposed Rules

    In its filing with the Commission, the Board included statements 
concerning the purpose of, and basis for, the proposed rules and 
discussed any comments it received on the proposed rules. The text of 
these statements may be examined at the places specified in Item IV 
below. The Board has prepared summaries, set forth in sections A, B, 
and C below, of the most significant aspects of such statements. In 
addition, the Board is requesting that, pursuant to Section 
103(a)(3)(C) of the Sarbanes-Oxley Act, the Commission approve the 
proposed rules for application to audits of emerging growth companies 
(``EGCs'').\1\ The Board's request is set forth in section D.
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    \1\ The term ``emerging growth company'' is defined in Section 
3(a)(80) of the Securities Exchange Act of 1934 (the ``Exchange 
Act'') (15 U.S.C. 78c(a)(80)). See also Inflation Adjustments and 
Other Technical Amendments Under Titles I and III of the JOBS Act, 
Release No. 33-10332 (Mar. 31, 2017), 82 FR 17545 (Apr. 12, 2017).
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A. Board's Statement of the Purpose of, and Statutory Basis for, the 
Proposed Rules

(a) Purpose
Summary
    The Board has adopted amendments to its standards for using the 
work of specialists (i.e., a person or firm possessing special skill or 
knowledge in a particular field other than accounting or auditing), 
including amendments to two existing auditing standards and the 
retitling and replacement of a third standard with an updated standard. 
The amendments are intended to enhance investor protection by 
strengthening the requirements for evaluating the work of a company's 
specialist, whether employed or engaged by the company, and applying a 
supervisory approach to both auditor-employed and auditor-engaged 
specialists. The amendments are also designed to be risk-based and 
scalable, so that the auditor's work effort to evaluate the 
specialist's work is commensurate with the risk of material 
misstatement associated with the financial statement assertion to which 
the specialist's work relates and the significance of the specialist's 
work to that assertion. These amendments should lead to more uniformly 
rigorous practices among audit firms of all sizes and enhance audit 
quality and the credibility of information provided in financial 
statements.
    Companies across many industries use specialists to assist in 
developing accounting estimates in their financial statements. 
Companies may also use specialists to interpret laws, regulations, and 
contracts or to evaluate the characteristics of certain physical 
assets. Those companies may use a variety of specialists, including 
actuaries, appraisers, other valuation specialists, legal specialists, 
environmental engineers, and petroleum engineers. Auditors often use 
the work of these companies' specialists as audit evidence. 
Additionally, auditors frequently use the work of auditors' specialists 
to assist in their evaluation of significant accounts and disclosures, 
including accounting estimates in those accounts and disclosures.
    As financial reporting frameworks continue to evolve and require 
greater use of estimates, including those based on fair value 
measurements, accounting estimates have become both more prevalent and 
significant. As a result, the use of the work of specialists also 
continues to increase in both frequency and significance. If a 
specialist's work is not properly overseen or evaluated by the auditor, 
there may be a heightened risk that the auditor's work will not be 
sufficient to detect a material misstatement in accounting estimates.
    To address this challenge, the Board has adopted amendments to its 
auditing standards that primarily relate to auditors' use of the work 
of specialists. First, AS 1105, Audit Evidence, is being amended to add 
a new Appendix A that addresses using the work of a company's 
specialist as audit evidence, based on the risk-based approach of the 
risk assessment standards.
New Appendix A of AS 1105
     Supplements the requirements in AS 1105 for circumstances 
when the auditor uses the work of the company's specialist as audit 
evidence, including requirements related to:
     Obtaining an understanding of the work and report(s), or 
equivalent communication, of the company's specialist(s) and related 
company processes and controls;
     Obtaining an understanding of, and assessing, the 
knowledge, skill, and ability of a company's specialist and the entity 
that employs the specialist (if other than the company) and the 
relationship to the company of the specialist and the entity that 
employs the specialist (if other than the company); and
     Performing procedures to evaluate the work of a company's 
specialist, including evaluating: (i) The data, significant 
assumptions, and methods (which may include models) used by the 
specialist, and (ii) the relevance and reliability of the specialist's 
work and its relationship to the relevant assertion.
     Aligns the requirements for using the work of a company's 
specialist with the risk assessment standards and the standard and 
related amendments adopted by the Board on auditing accounting 
estimates, including fair value measurements.
     Sets forth factors for determining the necessary evidence 
to support the auditor's conclusion regarding a relevant assertion when 
using the work of a company's specialist.
    Second, the Board has also amended AS 1201, Supervision of the 
Audit Engagement, by adding a new Appendix C on supervising the work of 
auditor-employed specialists, and retitling and replacing AS 1210, 
Using the Work of a Specialist (``existing AS 1210''), with new AS 
1210, Using the Work of an Auditor-Engaged Specialist (``AS 1210, as 
amended''), which sets forth

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requirements for using the work of auditor-engaged specialists.
New Appendix C of AS 1201
     Supplements the requirements for applying the supervisory 
principles in AS 1201.05-.06 when using the work of an auditor-employed 
specialist to assist the auditor in obtaining or evaluating audit 
evidence, including requirements related to:
     Informing the auditor-employed specialist of the work to 
be performed;
     Coordinating the work of the auditor-employed specialists 
with the work of other engagement team members; and
     Reviewing and evaluating whether the work of the auditor-
employed specialist provides sufficient appropriate evidence. 
Evaluating the work of the specialist includes evaluating whether the 
work is in accordance with the auditor's understanding with the 
specialist and whether the specialist's findings and conclusions are 
consistent with, among other things, the work performed by the 
specialist.
     Sets forth factors for determining the necessary extent of 
supervision of the work of the auditor-employed specialist.
AS 1210, as Amended
     Establishes requirements for using the work of an auditor-
engaged specialist to assist the auditor in obtaining or evaluating 
audit evidence;
     Includes requirements for reaching an understanding with 
an auditor-engaged specialist on the work to be performed and reviewing 
and evaluating the specialist's work that parallel the final amendments 
to AS 1201 for auditor-employed specialists;
     Sets forth factors for determining the necessary extent of 
review of the work of the auditor-engaged specialist;
     Amends requirements related to assessing the knowledge, 
skill, ability, and objectivity of the auditor-engaged specialist; and
     Describes objectivity, for these purposes, as the auditor-
engaged specialist's ability to exercise impartial judgment on all 
issues encompassed by the specialist's work related to the audit, and 
specifies the auditor's obligations when the specialist or the entity 
that employs the specialist has a relationship with the company that 
affects the specialist's objectivity.
    The final amendments strengthen the requirements for evaluating the 
work of a company's specialist and for supervising and evaluating the 
work of both auditor-employed and auditor-engaged specialists. The 
amendments also eliminate certain provisions of existing PCAOB 
standards, under which:
     The auditor has the same responsibilities under existing 
AS 1210 with respect to both a company's specialist and an auditor-
engaged specialist, even though those specialists have fundamentally 
different roles (i.e., the company uses the work of its specialist in 
the preparation of the financial statements); and
     Auditor-employed specialists, but not auditor-engaged 
specialists, are subject to risk-based supervision, even though both 
serve similar roles in helping auditors obtain and evaluate audit 
evidence.
    The Board adopted the final amendments after substantial outreach, 
including two rounds of public comment. In May 2015, the PCAOB issued a 
staff consultation paper to solicit views on various issues, including 
the potential need for standard setting. In June 2017, the Board 
requested comments on proposed amendments to the standards on using the 
work of specialists. The Board received comments on the staff 
consultation paper and the proposal. The Board's Standing Advisory 
Group (``SAG'') also discussed this issue at several meetings. 
Commenters generally supported the Board's objective of improving the 
quality of audits involving specialists, and suggested areas to further 
improve the amendments, modify proposed requirements that would not 
likely improve audit quality, and clarify the application of the 
amendments. In adopting these amendments, the Board has taken into 
account all of these comments and discussions, as well as observations 
from PCAOB oversight activities.
    In its consideration of the final amendments, the Board is mindful 
of the significant advances in technology that have occurred in recent 
years, including increased use of data analysis tools and emerging 
technologies. An increased use of technology-based tools, together with 
future developments in the use of data and technology, could have a 
fundamental impact on the audit process. The Board is actively 
exploring these potential impacts through ongoing staff research and 
outreach. For example, the PCAOB staff is currently researching the 
effects on auditing of data analytics, artificial intelligence, 
distributed ledger technology, and other emerging technology, assisted 
by a task force of the SAG.\2\
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    \2\ See PCAOB, Changes in Use of Data and Technology in the 
Conduct of Audits, available at https://pcaobus.org/Standards/research-standard-setting-projects/Pages/data-technology.aspx.
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    In the context of this rulemaking, the Board considered how changes 
in technology could affect the use of specialists by companies, the use 
of the work of companies' specialists by auditors as audit evidence, 
and the use of auditor-employed and auditor-engaged specialists by 
auditors to obtain and evaluate audit evidence. The Board believes that 
the final amendments are sufficiently principles-based and flexible to 
accommodate continued advances in the use of data and technology by 
both companies and auditors. The Board will continue to monitor 
advances in this area and any effect they may have on the application 
of the final amendments.
    The amendments will apply to all audits conducted under PCAOB 
standards. Subject to approval by the Commission, the amendments take 
effect for audits for fiscal years ending on or after December 15, 
2020.
(b) Statutory Basis
    The statutory basis for the proposed rules is Title I of the Act.

B. Board's Statement on Burden on Competition

    Not applicable. The Board's consideration of the economic impacts 
of the proposed rules is discussed in section D below.

C. Board's Statement on Comments on the Proposed Rules Received From 
Members, Participants or Others

    The Board released the proposed rules for public comment in 
Proposed Amendments to Auditing Standards for Auditor's Use of the Work 
of Specialists, PCAOB Release No. 2017-003 (June 1, 2017) 
(``Proposal''). The PCAOB also issued for public comment Staff 
Consultation Paper No. 2015-01, The Auditor's Use of the Work of 
Specialists (May 28, 2015) (``SCP''). Copies of Release No. 2017-003, 
the SCP, and the comment letters received in response to the PCAOB's 
requests for comment are available on the PCAOB's website at https://pcaobus.org/Rulemaking/Pages/docket-044-auditors-use-work-specialists.aspx. The PCAOB received 80 written comment letters. The 
Board's response to the comments received and the changes made to the 
rules in response to the comments received are discussed below.

Background

    Companies across many industries use various types of specialists 
to assist in developing accounting estimates in

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their financial statements.\3\ Companies may also use specialists to 
interpret laws, regulations, and contracts or to evaluate the 
characteristics of certain physical assets. Those companies may use a 
variety of specialists, including actuaries, appraisers, other 
valuation specialists, legal specialists, environmental engineers, and 
petroleum engineers. Auditors often use the work of these companies' 
specialists as audit evidence. In addition, auditors frequently use the 
work of auditors' specialists to assist in their evaluation of 
significant accounts and disclosures, including accounting estimates in 
those accounts and disclosures.
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    \3\ As used in this notice, a specialist is a person (or firm) 
possessing special skill or knowledge in a particular field other 
than accounting or auditing.
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    The use of fair value measurements and other accounting estimates 
continues to grow in financial reporting with, for example, increasing 
complexity in business transactions and changes in the financial 
reporting frameworks. As a result, the use of the work of specialists 
continues to increase in both frequency and significance.\4\ If a 
specialist's work is not properly overseen or evaluated, however, there 
is heightened risk that the auditor's work will not be sufficient to 
detect a material misstatement in accounting estimates.
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    \4\ See, e.g., Karin Barac, Elizabeth Gammie, Bryan Howieson, 
and Marianne van Staden, The Capability and Competency Requirements 
of Auditors in Today's Complex Global Business Environment, at 83 
(Mar. 2016) (report commissioned by the Institute of Chartered 
Accountants of Scotland and the Financial Reporting Council) 
(stating that ``audit teams now include many more experts than in 
the past, and for some industries, particularly financial services, 
this was a welcome development.'').
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    The amendments to the standards for using the work of specialists 
are intended to improve audit quality by strengthening the requirements 
for evaluating the work of a company's specialist and applying a risk-
based supervisory approach to both auditor-employed and auditor-engaged 
specialists. These enhancements should also lead to improvements in 
practices, commensurate with the associated risk, among audit firms of 
all sizes. The expected increase in audit quality should also enhance 
the credibility of information provided to investors.

Rulemaking History

    The amendments to the auditing standards adopted by the Board 
(``final amendments'' or ``final requirements'') reflect public 
comments on both the SCP and the Proposal. In May 2015, the PCAOB 
issued the SCP to solicit comments on various issues related to the 
auditor's use of the work of a company's specialist and an auditor's 
specialist, including possible approaches for changes to PCAOB 
standards and the potential economic impacts of those alternatives.
    In June 2017, the PCAOB issued the Proposal to solicit comments on 
amendments to PCAOB standards to strengthen the requirements for the 
auditor's use of the work of specialists. The Proposal was informed by 
comments on the SCP. The Board received 35 comment letters on the 
Proposal from commenters across a range of affiliations. The final 
amendments are informed by comments on the Proposal. Those comments are 
discussed throughout this notice.
    In addition, the Board's approach has been informed by, among other 
things: (1) Observations from PCAOB oversight activities and SEC 
enforcement actions; (2) the International Auditing and Assurance 
Standards Board's (``IAASB'') and the American Institute of Certified 
Public Accountants' Auditing Standards Board's auditing standards and 
IAASB's post-implementation review; \5\ (3) substantial outreach, 
including discussions with members of the SAG; \6\ and (4) the results 
of academic research.
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    \5\ See IAASB, Clarified International Standards on Auditing--
Findings from the Post-Implementation Review, at 44-45 (July 2013).
    \6\ See SAG meeting briefing papers and webcast archives (Nov. 
29-30, 2017, Nov. 30-Dec. 1, 2016, Nov. 12-13, 2015, June 18, 2015, 
Oct. 14-15, 2009, and Feb. 9, 2006), available on the Board's 
website.
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Overview of Existing Requirements

    The primary standard that applies when auditors use the work of 
auditor-engaged specialists or company specialists is existing AS 1210. 
The primary standard that applies when auditors use the work of 
auditor-employed specialists in an audit is AS 1201. Existing AS 1210 
was adopted by the Board in 2003 shortly after the PCAOB's 
inception.\7\ AS 1201 was one of eight risk assessment standards 
adopted by the Board in 2010.\8\
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    \7\ See Establishment of Interim Professional Auditing 
Standards, PCAOB Release No. 2003-006 (Apr. 18, 2003). AS 1210 was 
originally adopted by the PCAOB as AU sec. 336. The PCAOB renumbered 
AU sec. 336 as AS 1210 when it reorganized its auditing standards. 
See Reorganization of PCAOB Auditing Standards and Related 
Amendments to PCAOB Standards and Rules, PCAOB Release No. 2015-002 
(Mar. 31, 2015).
    \8\ See Auditing Standards Related to the Auditor's Assessment 
of and Response to Risk and Related Amendments to PCAOB Standards, 
PCAOB Release No. 2010-004 (Aug. 5, 2010). Prior to 2010, auditors 
supervised employed specialists under AU sec. 311, Planning and 
Supervision. Additionally, paragraph .16 of AS 2101, Audit Planning, 
requires the auditor to determine whether specialized skill or 
knowledge is needed to perform appropriate risk assessments, plan or 
perform audit procedures, or evaluate audit results.
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    Existing AS 1210 provides that a specialist is ``a person (or firm) 
possessing special skill or knowledge in a particular field other than 
accounting or auditing.'' \9\ Existing AS 1210 also states that income 
taxes and information technology (``IT'') are specialized areas of 
accounting and auditing, and therefore are outside the scope of the 
standard.\10\ Existing AS 1210 applies when (1) a company engages or 
employs a specialist and the auditor uses that specialist's work as 
evidence in performing substantive tests to evaluate material financial 
statement assertions or (2) an auditor engages a specialist and uses 
that specialist's work as evidence in performing substantive tests to 
evaluate material financial statement assertions.\11\
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    \9\ See existing AS 1210.01.
    \10\ See footnote 1 of existing AS 1210.
    \11\ See existing AS 1210.03.
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    AS 1201 establishes requirements for the supervision of the audit 
engagement, including supervising the work of engagement team 
members.\12\ The auditor supervises a specialist employed by the 
auditor's firm who participates in the audit under AS 1201.\13\ As 
members of the engagement team under PCAOB auditing standards, auditor-
employed specialists are to be assigned based on their knowledge, 
skill, and ability.\14\ AS 1201 also applies in situations in which 
persons with specialized skill or knowledge in IT or income taxes 
participate in the audit, regardless of whether they are employed or 
engaged by the auditor's firm.\15\
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    \12\ See AS 1201.01.
    \13\ See AS 1201.05-.06.
    \14\ See paragraph .05a of AS 2301, The Auditor's Responses to 
the Risks of Material Misstatement, and paragraph .06 of AS 1015, 
Due Professional Care in the Performance of Work. In addition, the 
requirements in PCAOB auditing standards for determining compliance 
with independence and ethics requirements also include assessing the 
independence of auditor-employed specialists. See AS 2101.06b.
    \15\ See footnote 1 of existing AS 1210.
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    Using the work of a company's specialist and an auditor-engaged 
specialist under existing AS 1210. Existing AS 1210 requires that the 
auditor perform the following procedures when using the work of a 
company's specialist or an auditor-engaged specialist:
     Evaluate the professional qualifications of the 
specialist; \16\
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    \16\ See existing AS 1210.08.
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     Obtain an understanding of the nature of the specialist's 
work; \17\
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    \17\ See existing AS 1210.09.
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     Evaluate the relationship of the specialist to the 
company, including circumstances that might impair the specialist's 
objectivity; \18\ and
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    \18\ See existing AS 1210.10-.11.

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     In using the findings of the specialist: \19\
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    \19\ See existing AS 1210.12.
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     Obtain an understanding of the methods and assumptions 
used by the specialist;
     Make appropriate tests of data provided to the specialist; 
and
     Evaluate whether the specialist's findings support the 
financial statement assertions.
    Using the work of a company's specialist when auditing fair value 
measurements under AS 2502.\20\ In circumstances when a company's 
specialist develops assumptions used in a fair value measurement and 
the auditor tests the company's process, the auditor is required to 
evaluate the reasonableness of those assumptions as if the assumptions 
were developed by the company,\21\ as well as to comply with the 
requirements of existing AS 1210.
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    \20\ AS 2502, Auditing Fair Value Measurements and Disclosures, 
is being superseded in a separate PCAOB release. See Auditing 
Accounting Estimates, Including Fair Value Measurements and 
Amendments to PCAOB Auditing Standards, PCAOB Release No. 2018-005 
(Dec. 20, 2018) (``Estimates Release'').
    \21\ See footnote 2 of AS 2502.
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    Supervising the work of auditor-employed specialists under AS 1201. 
This standard establishes requirements regarding the auditor's 
supervision of an audit engagement, including supervising the work of 
auditor-employed specialists and other members of the engagement team. 
AS 1201, as it relates to the supervision of auditor-employed 
specialists, provides that:
    (1) The engagement partner and others who assist the engagement 
partner in supervising the audit should:
     Inform engagement team members of their responsibilities;
     Direct engagement team members to bring significant 
accounting and auditing issues arising during the audit to the 
attention of the engagement partner or other engagement team members 
performing supervisory activities; and
     Review the work of engagement team members to evaluate 
whether:
     The work was performed and documented;
     The objectives of the procedures were achieved; and
     The results of the work support the conclusions 
reached.\22\
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    \22\ See AS 1201.05.
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    (2) The necessary extent of supervision depends on, for example, 
the nature of the work performed, the associated risks of material 
misstatement, and the knowledge, skill, and ability of those being 
supervised.\23\
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    \23\ See AS 1201.06.
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Existing Practice
    The PCAOB's understanding of audit practice at both larger audit 
firms \24\ and smaller audit firms \25\ under existing PCAOB standards 
has been informed by, among other things, the collective experience of 
PCAOB staff, observations from oversight activities of the Board, 
enforcement actions of the SEC, comments received on the Proposal, and 
discussions with the SAG, audit firms, and specialist entities.
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    \24\ Unless otherwise indicated, the term ``larger audit firms'' 
refers to U.S. audit firms that are registered with the PCAOB and 
issue audit reports for more than 100 issuers (and are therefore 
annually inspected by the PCAOB). This term also refers to non-U.S. 
audit firms that are registered with the PCAOB and affiliated with 
one of the six largest global networks, based on information on 
network affiliations reported by non-US. audit firms on Form 2 in 
2017 and identified on the ``Global Network'' overview page, 
available on the Board's website.
    \25\ Unless otherwise indicated, the term ``smaller audit 
firms'' refers to PCAOB-registered audit firms that do not meet the 
definition of a ``larger audit firm'' as provided in footnote 24. 
These firms generally consist of firms that issued audit reports for 
100 or fewer issuers and are not affiliated with any of the six 
largest global networks identified on the ``Global Network'' 
overview page, available on the Board's website.
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    These discussions have included outreach by the PCAOB staff to 
audit firms and specialist entities to obtain information on: (1) How 
auditors evaluate the competence and objectivity of auditor-engaged 
specialists and company specialists; (2) how auditors evaluate the work 
performed by an auditor-employed specialist, an auditor-engaged 
specialist, and a company's specialist; and (3) economic and 
demographic considerations relating to the market for services provided 
by specialists. The outreach has informed the PCAOB's understanding of 
existing practice at both larger and smaller audit firms. Most 
commenters who addressed the topic agreed that the Proposal accurately 
described existing audit practices regarding the use of the work of 
specialists. Commenters also generally supported the PCAOB's assessment 
that the use and importance of specialists has increased due to 
increasing complexity in business transactions and financial reporting 
requirements.
Overview of Existing Practice
    When existing AS 1210 was originally issued in the early 1970s, the 
use of the work of specialists was largely confined to pension 
obligations, insurance reserves, and extractive industry reserves. 
Since then, the use of the work of specialists has increased in both 
frequency and significance.
    Companies across many industries use the work of specialists to: 
(1) Assist them in developing accounting estimates, including fair 
value measurements presented in the companies' financial statements; 
(2) interpret laws, regulations, and contracts; or (3) evaluate 
characteristics of physical assets, as shown in Figure 1 below. In 
those circumstances, the reliability of a company's financial 
statements may depend in part on the quality of the work of a company's 
specialist.

[[Page 13446]]

  Figure 1: Examples of Activities That Involve the Work of Specialists
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Valuation:
    Assets acquired and liabilities assumed in business combinations
    Environmental remediation contingencies
    Goodwill impairments
    Insurance reserves
    Intangible assets
    Pension and other post-employment obligations
    Impairment of real estate or other long-term assets
    Financial instruments
Legal interpretations:
    Legal title to property
    Laws, regulations, or contracts
Evaluation of physical and other characteristics:
    Materials stored in stockpiles
    Mineral reserves and condition
    Oil and gas reserves
    Property, plant, and equipment useful lives and salvage values
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    Auditors also increasingly use the work of specialists in their 
audits. Auditors may:
     Use the work of a company's specialist--employed or 
engaged--as audit evidence; or
     Use the work of an auditor's specialist--employed or 
engaged--to assist the auditor in obtaining and evaluating audit 
evidence.
    Figure 2 illustrates potential ways that auditors use specialists 
in an audit.
[GRAPHIC] [TIFF OMITTED] TN04AP3.002

    The company's specialist (A and B above) is employed or engaged by 
the company to perform work that the company uses in preparing its 
financial statements, which the auditor may use as audit evidence with 
respect to auditing significant accounts and disclosures. The auditor's 
specialist (C and D above) performs work to assist the auditor in 
obtaining and evaluating audit evidence with respect to a relevant 
assertion of a significant account or disclosure.
    The PCAOB understands that audit practices under existing PCAOB 
standards vary among smaller and larger audit firms when auditors use 
the work of a specialist in an audit.\26\ For example, smaller audit 
firms are more likely to use the work of a company's specialist than to 
employ or engage their own specialist. Larger audit firms generally 
require their engagement teams to evaluate the work of the company's 
specialist, including the specialist's methods and assumptions, and 
often employ specialists to assist their audit personnel in evaluating 
that work.\27\ The following paragraphs discuss in more detail the 
practices of smaller firms and larger firms in audits of issuers, 
brokers, and dealers under existing PCAOB standards.
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    \26\ As discussed in section D, an analysis of inspection data 
by PCAOB staff suggests that larger audit firms generally use the 
work of specialists more often than smaller audit firms do.
    \27\ An analysis by PCAOB staff indicates that smaller firms 
predominantly use the work of an auditor's specialist in valuation 
areas, and seldom use the work of an auditor's specialist in other 
areas, whereas larger firms tend to use the work of an auditor's 
specialist in a wider range of audit areas, even though they also 
primarily use the work of specialists in valuation areas.
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    Smaller firm practices. Smaller firm practices generally are based 
on the required procedures in existing PCAOB standards, primarily 
existing AS 1210. Smaller firms typically evaluate the

[[Page 13447]]

competence, relationships to the company, and work of the company's 
specialist through inquiries of the company's specialist. For example, 
smaller firms may send a company's specialist a questionnaire to obtain 
information regarding the specialist's professional qualifications and 
the existence of relationships with the company that could impair the 
specialist's objectivity. Further, smaller firms typically do not 
evaluate the appropriateness of a specialist's methods (it is not 
required by existing AS 1210), and any evaluation by smaller firms of 
the assumptions of a company's specialist is generally confined to 
circumstances when the specialist develops assumptions used in a fair 
value measurement covered by AS 2502.
    In circumstances when smaller firms engage an auditor's specialist, 
some firms perform the procedures specified in existing AS 1210. Other 
firms perform procedures similar to those in AS 1201 for supervising 
members of the engagement team. For example, some firms evaluate 
whether the auditor-engaged specialist's work supports the financial 
statement assertions, while other firms go further by also evaluating 
whether (1) the specialist's work was performed and documented, (2) the 
objectives of the specialist's procedures were achieved, and (3) the 
results of the specialist's work support the conclusions reached. One 
commenter noted that smaller firms may also use an auditor's specialist 
in evaluating the work of a company's specialist.
    Larger firm practices. Some larger audit firms evaluate the methods 
and assumptions used by company specialists when they test the 
company's process for developing accounting estimates, even though this 
evaluation is currently required only for significant assumptions 
developed by the company's specialist in conjunction with fair value 
measurements and disclosures.\28\ Many larger firms employ their own 
specialists, who serve on engagement teams and assist with the 
evaluation of the work of company specialists.
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    \28\ See footnote 2 of AS 2502.
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    Auditor-employed specialists at larger firms are generally involved 
early in the audit, usually during planning meetings with other members 
of the engagement team. Also, in planning the audit, auditors generally 
reach an understanding with auditor-employed specialists, documented in 
a memorandum, regarding the scope of work to be performed and the 
respective responsibilities of the auditor and the specialist. The 
items covered in that memorandum typically include: (1) The nature, 
scope, and objectives of the specialist's work; \29\ (2) the role and 
responsibilities of the auditor and the specialist; \30\ and (3) the 
nature, timing, and extent of communication between the auditor and the 
specialist.\31\ The auditor communicates with the specialist as the 
work progresses to become aware of issues as they arise. When the 
specialist completes his or her work, the auditor reviews the 
specialist's work, which is typically documented in a separate report 
or memorandum.
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    \29\ Examples include whether the specialist is testing (or 
assisting in testing) the company's process for developing an 
accounting estimate or developing (or assisting in developing) an 
independent expectation of the estimate.
    \30\ For example, the documentation might identify the 
respective responsibilities of the auditor and the specialist for 
evaluating data, significant assumptions, and methods used by the 
company or the company's specialist.
    \31\ Examples include administrative matters, such as the 
timing, budget, and other staffing-related issues relevant to the 
specialist's work, or the protocols for discussing and resolving 
findings or issues identified by the specialist.
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    In some instances, larger firms may use the work of a company's 
specialist without involving an auditor's specialist, particularly when 
the risk of material misstatement is low or the firm does not employ a 
specialist with expertise in the particular field. Alternatively, 
although infrequently, larger firms may engage a specialist with 
expertise in the particular field. When larger firms engage 
specialists, some firms perform the procedures specified in existing AS 
1210 described above. Other firms perform procedures in such situations 
that are similar to the procedures for supervising the work of auditor-
employed specialists under AS 1201.

Observations From Audit Inspections and Enforcement Cases

    The Board's understanding of audit practice under existing PCAOB 
standards has been informed in part by observations from PCAOB 
oversight activities and SEC enforcement actions, including (1) audit 
deficiencies of both larger and smaller firms, and related remedial 
actions to address the deficiencies and (2) enforcement actions where 
the work of a specialist was used in the audit.
    Inspections observations. Over the past several years, the 
observations from PCAOB inspections have included instances in which 
the auditor used the work of a company's specialist without performing 
the procedures required by existing PCAOB standards.\32\ Recent 
findings include instances in which auditors did not: (1) Evaluate the 
reasonableness of assumptions used by a company's specialist in 
developing fair value measurements; (2) obtain an understanding of 
methods or assumptions used by the company's specialist; (3) test the 
accuracy and completeness of company-provided data used by the 
company's specialist; or (4) evaluate the professional qualifications 
of the company's specialist.
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    \32\ See existing AS 1210 and AS 2502.
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    Over the past several years, the observations from PCAOB 
inspections also have indicated that auditors, at times, did not 
fulfill their responsibilities under existing standards when using the 
work of an auditor's specialist. These findings were more common than 
those related to using the work of a company's specialist over the same 
period. The observations included instances in which auditors did not: 
(1) Reach an understanding with the specialist regarding his or her 
responsibilities; (2) adequately evaluate the work performed by the 
specialist; or (3) consider contradictory evidence identified by the 
specialist or resolve discrepancies or other concerns that the 
specialist identified. More recently, PCAOB inspection staff have 
observed a decline in the number of instances by some firms in which 
auditors did not perform sufficient procedures related to the work of 
an auditor's specialist.
    There are indications that some firms have undertaken remedial 
actions in response to the findings related to the auditor's use of the 
work of an auditor's specialist. In most cases, such actions included 
enhancements to firm methodologies to improve coordination between the 
auditor and the auditor's specialist through earlier and more frequent 
communications. These enhancements may have contributed, at least in 
part, to the decline in findings described above. Not all firms, 
however, have changed their methodologies, resulting in inconsistent 
practices in this area. In addition, unlike the findings related to the 
auditor's use of the work of an auditor's specialist, PCAOB inspections 
staff have not observed a similar change in the frequency of findings 
related to the auditor's use of the work of a company's specialist.

[[Page 13448]]

    Enforcement actions. Both the SEC \33\ and the PCAOB \34\ have 
brought enforcement actions involving situations where auditors 
allegedly failed to comply with auditing standards when using the work 
of specialists. For example, such proceedings have involved allegations 
that auditors failed to (1) perform audit procedures to address the 
risks of material misstatements in a company's financial statements 
that were prepared in part based on the work of a company's specialist 
\35\ or (2) comply with certain requirements of existing AS 1210 when 
using the work of a company's specialist (for example, requirements to 
evaluate the professional qualifications of the specialist, obtain an 
understanding of the methods and assumptions used by the specialist, 
evaluate the relationship of the specialist to the company, and apply 
additional procedures to address a material difference between the 
specialist's findings and the assertions in the financial 
statements).\36\ Several of those proceedings were brought in recent 
years, suggesting that problems persist in this area.
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    \33\ See, e.g., KPMG LLP and John Riordan, CPA, SEC Accounting 
and Auditing Enforcement Release (``AAER'') No. 3888 (Aug. 15, 
2017); Miller Energy Resources, Inc., Paul W. Boyd, CPA, David M. 
Hall, and Carlton W. Vogt, III, CPA, AAER No. 3673 (Aug. 6, 2015); 
Troy F. Nilson, CPA, SEC AAER No. 3264 (Apr. 8, 2011); and 
Accounting Consultants, Inc., and Carol L. McAtee, CPA, SEC AAER No. 
2447 (June 27, 2006).
    \34\ See, e.g., Tarvaran Askelson & Company, LLP, Eric Askelson, 
and Patrick Tarvaran, PCAOB Release No. 105-2018-001 (Feb. 27, 
2018); Grant Thornton LLP, PCAOB Release No. 105-2017-054 (Dec. 19, 
2017); KAP Purwantono, Sungkoro & Surja, Roy Iman Wirahardja, and 
James Randall Leali, PCAOB Release No. 105-2017-002 (Feb. 9, 2017); 
Arturo Vargas Arellano, CPC, PCAOB Release No. 105-2016-045 (Dec. 5, 
2016); Gordon Brad Beckstead, CPA, PCAOB Release No. 105-2015-007 
(Apr. 1, 2015); and Chisholm, Bierwolf, Nilson & Morrill, LLC, Todd 
D. Chisholm, CPA, and Troy F. Nilson, CPA, PCAOB Release No. 105-
2011-003 (Apr. 8, 2011).
    \35\ See, e.g., Gordon Brad Beckstead, CPA, PCAOB Release No. 
105-2015-007.
    \36\ See, e.g., Grant Thornton LLP, PCAOB Release No. 105-2017-
054; KAP Purwantono, Sungkoro & Surja, PCAOB Release No. 105-2017-
002; Arturo Vargas Arellano, CPC, PCAOB Release No. 105-2016-045; 
Chisholm, Bierwolf, Nilson & Morrill, LLC, PCAOB Release No. 105-
2011-003; and Miller Energy Resources, Inc., SEC AAER No. 3673.
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Reasons To Improve Auditing Standards

    The improvements to PCAOB standards are intended to direct auditors 
to devote more attention to the work of a company's specialist and 
enhance the coordination between an auditor and the auditor's 
specialist--employed or engaged. The final amendments also align with 
the Board's risk assessment standards and acknowledge more clearly the 
different roles of a company's specialist, an auditor-employed 
specialist, and an auditor-engaged specialist. The Board believes that 
these improvements will enhance both audit quality and the credibility 
of the information provided in a company's financial statements.

Areas of Improvement

    The Board has identified two important areas where improvements are 
warranted to existing standards, discussed below: (1) Strengthening the 
requirements for evaluating the work of a company's specialist and (2) 
applying a risk-based supervisory approach to auditor-employed and 
auditor-engaged specialists.
Strengthening the Requirements for Evaluating the Work of a Company's 
Specialist
    Existing AS 1210 is the primary standard that applies when auditors 
use the work of an auditor-engaged specialist or a company's 
specialist. By its terms, existing AS 1210 applies when (1) a company 
engages or employs a specialist and the auditor uses that specialist's 
work as evidence in performing substantive tests to evaluate material 
financial statement assertions or (2) an auditor engages a specialist 
and uses that specialist's work as evidence in performing substantive 
tests to evaluate material financial statement assertions.
    In practice, however, a company's specialist and an auditor-engaged 
specialist have fundamentally different roles: The company uses the 
work of a specialist in the preparation of its financial statements, 
whereas an auditor's specialist performs work to assist the auditor in 
obtaining and evaluating audit evidence. By imposing the same 
requirements for using the work of a company's specialist and an 
auditor-engaged specialist, existing AS 1210 does not clearly reflect 
the different roles of such specialists.
    In addition, existing AS 1210 does not expressly require an auditor 
to evaluate the appropriateness of a company specialist's methods and 
assumptions.\37\ Instead, it requires the auditor to obtain an 
understanding of the methods and assumptions used by the specialist, a 
less rigorous procedure. Existing AS 1210 also includes certain 
provisions that circumscribe the auditor's responsibilities related to 
the work of a specialist, including statements that: (1) The 
appropriateness and reasonableness of methods and assumptions used, and 
their application, are the responsibility of the specialist; (2) the 
auditor ordinarily would use the work of the specialist unless the 
auditor's procedures lead him or her to believe the findings are 
unreasonable in the circumstances; and (3) if the auditor determines 
that the specialist's findings support the related assertions in the 
financial statements, he or she reasonably may conclude that sufficient 
appropriate evidential matter has been obtained.\38\
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    \37\ The evaluation of the reasonableness of assumptions 
developed by a company's specialist is required only in 
circumstances when the specialist develops assumptions used in a 
fair value measurement in accordance with AS 2502. AS 2502 is being 
superseded in a separate PCAOB release. See Estimates Release, supra 
note 20.
    \38\ See existing AS 1210.12-.13.
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    When an auditor uses the work of a company's specialist, the 
requirements in existing AS 1210 allow the auditor to plan and perform 
audit procedures that may not be commensurate with the risk of material 
misstatement inherent in the work of the specialist, thereby allowing 
the auditor to use the work and conclusions of a company's specialist 
without performing procedures to evaluate that specialist's work. Some 
audit firms, primarily larger firms, go beyond the requirements in 
existing AS 1210 and generally require their engagement teams to 
evaluate the work of a company's specialist, including the specialist's 
methods and assumptions, and often employ specialists to assist their 
audit personnel in evaluating that work. Existing audit practices in 
this regard, however, vary among firms.
    The foregoing factors indicate that improvements to PCAOB standards 
for using the work of a company's specialists are needed and that 
increasing auditors' attention to the work of a company's specialists 
with respect to significant accounts and disclosures will enhance 
investor protection. In the Board's view, investor protection will be 
enhanced by requiring auditors to do more than merely obtain an 
understanding of the methods and significant assumptions used by the 
specialist.
Applying a Risk-Based Supervisory Approach to Both Auditor-Employed and 
Auditor-Engaged Specialists
    The primary standard that applies when auditors use the work of an 
auditor-employed specialist in an audit is AS 1201. That standard 
establishes requirements regarding the auditor's supervision of the 
audit engagement, including supervision of a specialist employed by the 
auditor's firm who participates in the audit. While AS 1201 is risk-
based and scalable, it does not specifically address how to apply its 
supervisory procedures to promote

[[Page 13449]]

effective coordination between an auditor and a specialist and 
evaluation by the auditor of the work of an auditor-employed 
specialist.
    The primary standard that applies when auditors use the work of an 
auditor-engaged specialist in an audit is existing AS 1210. The 
requirements in this standard differ from and are less rigorous than 
the requirements that apply when using auditor-employed specialists, 
even though auditor-employed and auditor-engaged specialists serve 
similar roles in helping auditors to obtain and evaluate audit 
evidence. For example, existing AS 1210 provides that the auditor 
should ``obtain an understanding'' of the nature of the work performed 
by an auditor-engaged specialist, including the objectives and scope of 
the specialist's work, whereas AS 1201 requires the auditor to review 
the work of an auditor-employed specialist to ``evaluate'' whether the 
work was performed and documented, the objectives of the procedures 
were achieved, and the results of the work support the conclusions 
reached.
    The PCAOB's observations regarding existing audit practices in this 
area also reveal differences in the application of the auditing 
standards regarding the use of the work of auditor-employed and 
auditor-engaged specialists. For example, in circumstances when audit 
firms engage specialists, some firms perform the procedures specified 
in existing AS 1210, while other firms perform procedures that are 
similar to the procedures for supervising the work of auditor-employed 
specialists under AS 1201.
    These factors indicate that investor protection can be enhanced by 
improving PCAOB standards for applying a risk-based supervisory 
approach to auditor-employed specialists, and extending those 
requirements to auditor-engaged specialists. This should promote a more 
uniform approach to the supervision of an auditor's specialists, 
whether employed or engaged, reflecting their similar roles. 
Specifically, investor protection can be enhanced by supplementing the 
existing supervision requirements under PCAOB standards with more 
specific direction on applying those principles when supervising the 
work of auditor-employed and auditor-engaged specialists. This 
includes, among other things, additional direction on reaching an 
understanding with auditor-employed and auditor-engaged specialists on 
the work to be performed and on reviewing and evaluating their work.

Comments on the Reasons for Standard Setting

    Many commenters on the Proposal broadly expressed support for 
revisions to the Board's standards for using the work of specialists or 
stated that the Proposal would lead to improvements in audit quality. 
For example, some commenters agreed with statements in the Proposal 
that the increasing use of specialists, due in part to the increasing 
use of fair value measurements in financial reporting frameworks and 
increasing complexity of business transactions, warranted strengthening 
existing requirements. A number of commenters also indicated that the 
requirements for using specialists should be risk-based and more 
closely aligned with the Board's risk assessment standards than 
existing standards. One of these commenters stated that the Board 
should be proactive in addressing issues relating to auditors' use of 
the work of specialists through standard setting as an alternative to 
devoting additional resources to inspections and enforcement based on 
existing standards.
    In addition, a number of commenters generally agreed with 
developing separate standards for using the work of a company's 
specialist, an auditor-employed specialist, and an auditor-engaged 
specialist. One commenter noted that separating these requirements 
could lead to better application in practice, especially among smaller 
CPA firms, while another commenter indicated that providing separate 
guidance for using the work of company specialists, auditor-employed 
specialists, and auditor-engaged specialists would be an improvement 
over existing standards. One commenter stated that inspections of 
audits involving the use of specialists had shown a need for 
improvement, and that the rationalization and enhancement of existing 
requirements would improve the efficiency and quality of audits.
    A few commenters on the Proposal questioned the reasons for 
revisions to PCAOB auditing standards relating to the use of the work 
of specialists.\39\ One commenter stated that the Proposal presented no 
clear evidence that audit deficiencies found by the PCAOB relating to 
the use of specialists resulted from deficiencies in the auditing 
standards. Another commenter stated that inspection findings did not 
necessarily warrant revisions to auditing standards and that it 
continued to question whether a fundamental change in audit standards 
was necessary. A third commenter stated that it did not believe that 
the case had been made for having separate standards for the use of 
auditor-employed and auditor-engaged specialists. Finally, a fourth 
commenter suggested that the Board should develop additional 
information on potential costs before proposing or adopting revisions 
to existing auditing standards, including through field testing of 
potential changes.\40\
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    \39\ Some commenters provided comments or expressed concerns 
about specific aspects of the proposed revisions to the Board's 
existing standards for using the work of specialists. The Board's 
consideration of these comments is discussed further below.
    \40\ See below for a more detailed discussion of the final 
amendments and clarifications of certain aspects of the proposed 
amendments, as set forth in the Proposal.
---------------------------------------------------------------------------

    The SAG has discussed specialist-related issues at a number of 
meetings.\41\ Many SAG members expressed support for: (1) Greater 
auditor responsibility for evaluating the work performed by a company's 
specialists; (2) similar responsibilities when auditors use the work of 
auditor-employed specialists and auditor-engaged specialists; and (3) 
better communication between auditors and their specialists, whether 
employed or engaged. Some SAG members, however, questioned the need for 
changes to the existing standards, asserting that auditors may not 
always have the necessary level of expertise to evaluate the work of 
certain specialists and, as a result, may need to rely on the work of 
specialists.
---------------------------------------------------------------------------

    \41\ See SAG meeting briefing papers and webcast archives (Nov. 
29-30, 2017, Nov. 30-Dec. 1, 2016, Nov. 12-13, 2015, June 18, 2015, 
Oct. 14-15, 2009, and Feb. 9, 2006), available on the Board's 
website.
---------------------------------------------------------------------------

    In adopting the final amendments, the Board has taken into account 
the comments received on the Proposal, as well as its other outreach 
activities. The information available to the Board--including the 
current regulatory baseline, observations from the Board's oversight 
activities, and substantial outreach--suggests that investors would 
benefit from strengthened and clarified standards for auditors in this 
area. The Board notes that aspects of the required procedures in the 
final amendments are similar to current auditing practices by some 
larger and smaller audit firms. While the Board does not expect that 
the final amendments will eliminate inspection deficiencies observed in 
practice, the final amendments are intended to clarify the auditor's 
responsibilities and align the requirements for using the work of 
specialists more closely with the Board's risk assessment standards. 
The final amendments also reflect a number of changes that were made 
after the Board's consideration of comments

[[Page 13450]]

received on the Proposal about the potential impact of the proposed 
requirements on auditors, issuers, and specialists.\42\
---------------------------------------------------------------------------

    \42\ See below for a more detailed discussion of changes 
reflected in the final amendments and section D for a more detailed 
discussion of economic considerations related to the adoption of the 
final amendments.
---------------------------------------------------------------------------

Overview of Final Rules

    The final amendments: (1) Add an appendix to AS 1105 with 
supplemental requirements for using the work of a company's specialist 
as audit evidence; (2) add an appendix to AS 1201 with supplemental 
requirements for supervising an auditor-employed specialist; and (3) 
replace existing AS 1210 with an updated standard for using the work of 
an auditor-engaged specialist. The key aspects of these amendments, 
which are intended to enhance the requirements in existing standards 
for using the work of a company's specialist, an auditor-employed 
specialist, and an auditor-engaged specialist, are discussed in this 
section. The ways in which the final amendments address the need for 
change from an economic perspective are discussed in section D.
    The final amendments have been informed by the Board's outreach 
activities. They are aligned with the Board's risk assessment 
standards, so that the necessary audit effort is commensurate with, 
among other things, the significance of the specialist's work to the 
auditor's conclusion regarding the relevant assertion and the 
associated risk. Many commenters on the Proposal supported aligning any 
new standards on using the work of specialists with any new standards 
related to auditing accounting estimates, including fair value 
measurements. The final amendments are aligned with the Estimates 
Release.
    Figure 3 summarizes the auditor's responsibilities and primary 
PCAOB standards for using the work of specialists applicable before and 
after the effective date of the final amendments.
[GRAPHIC] [TIFF OMITTED] TN04AP3.003

    In brief, the final amendments make the following changes to PCAOB 
auditing standards:
     Amend AS 1105.
     Add a new Appendix A \43\ that supplements the 
requirements in AS 1105 for circumstances when the auditor uses the 
work of the company's specialist as audit evidence, related to:
---------------------------------------------------------------------------

    \43\ As proposed, these requirements would have been set forth 
as Appendix B to AS 1105.
---------------------------------------------------------------------------

     Obtaining an understanding of the work and report(s), or 
equivalent communication, of the company's specialist(s) and related 
company processes and controls; \44\
---------------------------------------------------------------------------

    \44\ See AS 1105.A2, as adopted. Additionally, as amended, AS 
2110, Identifying and Assessing Risks of Material Misstatement, sets 
forth requirements for understanding company processes and controls 
related to the use of specialists.
---------------------------------------------------------------------------

     Obtaining an understanding of and assessing the knowledge, 
skill, and ability of a company's specialist and the entity that 
employs the specialist (if other than the company) and the relationship 
to the company of the specialist and the entity that employs the 
specialist (if other than the company); and
     Performing procedures to evaluate the work of a company's 
specialist, including evaluating: (i) The data, significant 
assumptions, and methods (which may include models) used by the 
specialist,\45\ and (ii) the relevance and reliability of the 
specialist's work and its relationship to the relevant assertion;
---------------------------------------------------------------------------

    \45\ This evaluation is not explicitly required under the 
Board's existing standards, other than under AS 2502 with respect to 
the significant assumptions of a company's specialist regarding fair 
value measurements and disclosures.
---------------------------------------------------------------------------

     Align the requirements for using the work of a company's 
specialist with the risk assessment standards and the

[[Page 13451]]

standard and related amendments adopted by the Board on auditing 
accounting estimates, including fair value measurements; \46\ and
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    \46\ Certain provisions of the final amendments include 
references to a new auditing standard AS 2501, Auditing Accounting 
Estimates, Including Fair Value Measurements (``AS 2501, as 
adopted''), which has been adopted by the Board in a separate 
release. See Estimates Release, supra note 20.
---------------------------------------------------------------------------

     Set forth factors for determining the necessary evidence 
to support the auditor's conclusion regarding a relevant assertion when 
using the work of a company's specialist.
     Amend AS 1201.
     Add a new Appendix C that supplements the requirements for 
applying the supervisory principles in AS 1201.05-.06 when using the 
work of an auditor-employed specialist to assist the auditor in 
obtaining or evaluating audit evidence, including requirements related 
to:
     Informing the auditor-employed specialist of the work to 
be performed;
     Coordinating the work of the auditor-employed specialists 
with the work of other engagement team members; and
     Reviewing and evaluating whether the work of the auditor-
employed specialist provides sufficient appropriate evidence. 
Evaluating the work of the specialist includes evaluating whether the 
work is in accordance with the auditor's understanding with the 
specialist and whether the specialist's findings and conclusions are 
consistent with, among other things, the work performed by the 
specialist.
     Set forth factors for determining the necessary extent of 
supervision of the work of the auditor-employed specialist.
     Replace existing AS 1210.
     Replace with AS 1210, as amended, Using the Work of an 
Auditor-Engaged Specialist, which establishes requirements for using 
the work of an auditor-engaged specialist to assist the auditor in 
obtaining or evaluating audit evidence;
     Include requirements for reaching an understanding with an 
auditor-engaged specialist on the work to be performed and reviewing 
and evaluating the specialist's work that parallel the final amendments 
to AS 1201 for auditor-employed specialists;
     Set forth factors for determining the necessary extent of 
review of the work of the auditor-engaged specialist;
     Amend requirements related to assessing the knowledge, 
skill, ability, and objectivity \47\ of the auditor-engaged specialist; 
and
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    \47\ Under the final amendments, the term ``objectivity'' is 
reserved for the auditor-engaged specialist and not used to describe 
the relationship to the company of a company's specialist or an 
auditor-employed specialist. See below for further discussion of 
objectivity.
---------------------------------------------------------------------------

     Describe objectivity, for purposes of the standard, as the 
auditor-engaged specialist's ability to exercise impartial judgment on 
all issues encompassed by the specialist's work related to the audit; 
and specify the auditor's obligations when the specialist or the entity 
that employs the specialist has a relationship with the company that 
affects the specialist's objectivity.
    The Board has also adopted a single standard to replace its 
existing standards on auditing accounting estimates and fair value 
measurements and set forth a uniform, risk-based approach designed to 
strengthen and enhance the requirements for auditing accounting 
estimates.\48\ Certain provisions of the final amendments in this 
notice include references to AS 2501, as adopted.
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    \48\ As discussed in the Estimates Release, supra note 20, the 
Board is retitling and replacing existing AS 2501, Auditing 
Accounting Estimates, and superseding AS 2502 and AS 2503, Auditing 
Derivative Instruments, Hedging Activities, and Investments in 
Securities. AS 2501, as adopted, also includes a special topics 
appendix that addresses certain matters relevant to auditing the 
fair value of financial instruments, including the use of pricing 
information from third parties as audit evidence.
---------------------------------------------------------------------------

    Most of those who commented on the proposed requirements regarding 
the use of the company's specialist expressed support for strengthening 
the requirements for evaluating the work of a company's specialist and 
aligning them with the Board's risk assessment standards. For example, 
one commenter stated that it agreed with statements in the Proposal 
that the proposed requirements may result in some auditors gaining a 
better understanding of a company's critical accounting estimates 
related to relevant financial statements and disclosures. Another 
commenter stated that the application of a risk-based approach to the 
testing and evaluation of the work of a company's specialist would 
reduce the risk of an auditor failing to sufficiently address the risks 
of material misstatement.
    A few commenters disagreed with the approach, or aspects of the 
approach, for evaluating the work of a company's specialist as 
described in the Proposal. One commenter asserted that additional 
clarification for using the work of a company's specialist was needed 
to address practicability issues and avoid unnecessary costs. Another 
commenter suggested that the amendments should place greater weight on 
the professional requirements and certifications for certain company 
specialists.
    The Board recognizes that the auditor does not have the same 
expertise as a person trained or qualified to engage in the practice of 
another profession. At the same time, establishing a uniform, risk-
based approach for using the work of a company's specialist more 
clearly acknowledges the different roles of a company's specialist and 
an auditor's specialist and builds upon improvements observed in the 
practices of certain firms. The final amendments also clarify aspects 
of the proposed amendments, including the procedures for evaluating the 
work of a company's specialist, so that the required procedures are 
both practical and risk-based, and reasonably designed to lead to 
improvements in audit quality.\49\
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    \49\ See below for a more detailed discussion of the final 
amendments and clarifications regarding using the work of a 
company's specialist.
---------------------------------------------------------------------------

    Commenters on the proposed requirements for using an auditor's 
specialist generally agreed with a risk-based supervisory approach for 
both auditor-employed and auditor-engaged specialists. For example, one 
commenter agreed that this approach would promote an improved, more 
uniform approach to the supervision of an auditor's specialists. 
Consistent with the view of these commenters, the final amendments 
apply a risk-based supervisory approach to both auditor-employed and 
auditor-engaged specialists, which should enhance investor protection.
    The subsections that follow discuss in more detail the final 
amendments. The subsections also include a comparison of the final 
requirements with the analogous requirements of the following standards 
issued by the IAASB and the Auditing Standards Board (``ASB'') of the 
American Institute of Certified Public Accountants:
IAASB Standards
     International Standard on Auditing 500, Audit Evidence 
(``ISA 500''); and
     International Standard on Auditing 620, Using the Work of 
an Auditor's Expert (``ISA 620'').
ASB Standards
     AU-C Section 500, Audit Evidence (``AU-C Section 500''); 
and
     AU-C Section 620, Using the Work of an Auditor's 
Specialist (``AU-C Section 620'').
    The comparison included in these subsections may not represent the 
views of the IAASB or ASB regarding the interpretation of their 
standards. The information presented in the subsections does not cover 
the application and explanatory material in

[[Page 13452]]

the IAASB standards or ASB standards.\50\
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    \50\ Paragraph A59 of ISA 200, Overall Objectives of the 
Independent Auditor and the Conduct of an Audit in Accordance with 
International Standards on Auditing, indicates that the application 
and other explanatory material section of the ISAs ``does not in 
itself impose a requirement'' but ``is relevant to the proper 
application of the requirements of an ISA.'' Paragraph .A64 of AU-C 
Section 200, Overall Objectives of the Independent Auditor and the 
Conduct of an Audit in Accordance with Generally Accepted Auditing 
Standards, states that, although application and other explanatory 
material ``does not in itself impose a requirement, it is relevant 
to the proper application of the requirements of an AU-C section.''
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Scope of Final Amendments

    The final amendments apply when an auditor uses the work of a 
``specialist.'' Thus, the scope of the requirements hinges largely on 
the meaning of the term ``specialist.'' As described in the Proposal, 
the Board sought to carry forward the meaning of the term 
``specialist'' from existing AS 1210, that is, a specialist is a person 
(or firm) possessing special skill or knowledge in a particular field 
other than accounting or auditing. The Board also sought to carry 
forward the concept from existing AS 1210 that income taxes and IT are 
specialized areas of accounting and auditing and thus are outside the 
scope of the final amendments.\51\ As discussed below, the final 
amendments retain, as proposed, the meaning of the term ``specialist,'' 
including the concept regarding income taxes and IT.
---------------------------------------------------------------------------

    \51\ See footnote 1 of existing AS 1210.
---------------------------------------------------------------------------

    Some commenters on the Proposal agreed with retaining the existing 
meaning of the term ``specialist.'' Other commenters suggested that the 
Board extend the scope of the Proposal to include persons with 
specialized skill or knowledge in certain areas of income taxes and IT 
(e.g., unusual or complex tax matters, artificial intelligence, and 
blockchain). One of these commenters also asserted that income tax and 
IT professionals often support both audit and consulting practices and, 
as a practical matter, are treated as specialists by auditors. One 
commenter requested guidance for applying the proposed requirements 
when a legal specialist is involved, while another commenter suggested 
that the Board explain in the final amendments that an individual who 
specializes in complex taxation law would be a legal specialist.
    One commenter suggested eliminating the distinction between 
expertise ``inside'' or ``outside'' the field of accounting and 
auditing with respect to an auditor's specialist because, in its view, 
determining when fields of expertise are outside of accounting and 
auditing is becoming more difficult. Another commenter stated that, in 
practice, it can be less than straightforward to differentiate between 
expertise in auditing and accounting and other areas. Other commenters, 
however, asserted that the Board should retain the concept in existing 
AS 1210 that an auditor is not expected to have the expertise of a 
person trained or qualified to engage in the practice of another 
profession or occupation.
    As used today, the term ``specialist'' is generally understood by 
auditors, and observations from PCAOB oversight activities do not 
indicate that there is significant confusion over the meaning of the 
terms ``specialist'' and ``specialized area of accounting and 
auditing,'' as they have been used in the standards. After considering 
the comments received on the Proposal, however, the final amendments 
retain the meaning of the term ``specialist'' as proposed, with certain 
clarifications discussed below.
    Specifically, the Board included a note to clarify when the final 
amendments apply to the work of an attorney used by the company.\52\ As 
under existing AS 1210, specialists under the final amendments include 
attorneys engaged by a company as specialists, such as attorneys 
engaged by the company to interpret contractual terms or provide a 
legal opinion. The final amendments apply when an auditor uses the work 
of a company's attorney as audit evidence in other matters relating to 
legal expertise, such as when a legal interpretation of a contractual 
provision or a legal opinion regarding isolation of transferred 
financial assets is necessary to determine appropriate accounting or 
disclosure under the applicable financial reporting framework. The 
final amendments also clarify that the scope of these amendments does 
not apply to information provided by a company's attorney concerning 
litigation, claims, or assessments that is used by the auditor pursuant 
to AS 2505, Inquiry of a Client's Lawyer Concerning Litigation, Claims, 
and Assessments.
---------------------------------------------------------------------------

    \52\ See second note to AS 1105.A1, as adopted.
---------------------------------------------------------------------------

    Consistent with existing AS 1210, income taxes and IT are outside 
the scope of the final amendments because they are specialized areas of 
accounting and auditing. For example, while specialized areas of income 
tax law involve legal specialists, accounting for income taxes remains 
an area of accounting and auditing. The Board added a footnote to 
Appendix A of AS 1105 that references AS 2505.08, as amended.\53\ A 
note to AS 2505.08, as amended, clarifies the auditor's responsibility 
regarding the use of the written advice or opinion of a company's tax 
advisor or a company's tax legal counsel as audit evidence.\54\ Also, 
to the extent that IT is used in information systems, auditors will 
still need to maintain sufficient technical knowledge to identify and 
assess risks and design procedures to respond to those risks and 
evaluate the audit evidence obtained. Accordingly, the Board does not 
believe that the need exists at this time to change the approach 
reflected in existing AS 1210 and designate particular areas of either 
income taxes or IT as outside the field of ``accounting and auditing.''
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    \53\ See footnote 1 to AS 1105.A1, as adopted.
    \54\ See note to AS 2505.08, as amended.
---------------------------------------------------------------------------

Comparison With Standards of Other Standard Setters

    ISA 620 uses the terms ``auditor's expert'' and ``management's 
expert'' in a manner analogous to the term ``specialist'' in the final 
amendments. ISA 620, however, does not address whether IT is a 
specialized field outside of accounting and auditing. The term 
``management's expert'' is also defined in ISA 500.
    AU-C Section 620 and AU-C Section 500 use the word ``specialist'' 
instead of ``expert.''

Amendments Related to Using the Work of a Company's Specialist

    The final amendments set forth requirements for using the work of a 
company's specialist as audit evidence. The amendments, which 
supplement the existing requirements of AS 1105, include:
     Obtaining an understanding of the work and report(s), or 
equivalent communication, of the company's specialist(s) and related 
company processes and controls;
     Obtaining an understanding of and assessing the knowledge, 
skill, and ability of the specialist and the entity that employs the 
specialist (if other than the company), and the relationship to the 
company of the specialist and the entity that employs the specialist 
(if other than the company); and
     Performing procedures to evaluate the work of a company's 
specialist, including evaluating: (1) The data, significant 
assumptions, and methods (which may include models) used by the 
specialist; and (2) the relevance and reliability of the specialist's 
work and its relationship to the relevant assertion.\55\
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    \55\ Key principles from Auditing Interpretation AI 11, Using 
the Work of a Specialist: Auditing Interpretations of AS 1210, and 
Auditing Interpretation AI 28, Evidential Matter Relating to Income 
Tax Accruals: Auditing Interpretations, related to the auditor's use 
of the work of a company's attorney and the use of written tax 
advice or opinions as audit evidence have been incorporated in AS 
1105.A1, as adopted, and a note added to AS 2505.08, as amended.

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[[Page 13453]]

    Commenters on the Proposal generally supported a risk-based 
approach for using the work of a company's specialist, as set forth in 
the proposed amendments. Many commenters also stated that there was a 
need to establish a separate standard for using the work of a company's 
specialist. However, a number of commenters questioned various aspects 
of the amendments, including the need for revisions to existing AS 1210 
relating to the use of the work of a company's specialist. 
Additionally, some commenters requested clarifications or suggested 
changes to the proposed requirements. These and other comments are 
discussed below. A number of these comments resulted in revisions and 
clarifications to the final amendments.

Obtaining an Understanding of the Work of the Company's Specialist

See AS 1105.A2, as Adopted, and AS 2110.28A, as Adopted
    The proposed amendments to AS 1105 provided that obtaining an 
understanding of the company's information system relevant to financial 
reporting would encompass obtaining an understanding of the work and 
report(s) of the company's specialist(s) and related company processes 
and controls.\56\
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    \56\ See proposed AS 1105.B2.
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    Some commenters supported the proposed requirement because, in 
their view, an understanding of the company's processes for using the 
work of company specialists is integral to the auditor's understanding 
of the information system relevant to financial reporting. Two 
commenters asserted that such controls are important for the auditor to 
consider when evaluating the work of a company's specialist and 
determining the necessary audit procedures. One commenter expressed 
concern that the proposed requirement was too broad and suggested that 
the auditor's understanding should instead be part of the evaluation of 
the specialist's objectivity. In addition, two commenters questioned 
whether the Board intended to require the auditor to evaluate the 
design of controls over the use of company specialists, even if the 
auditor was not performing an audit of internal control over financial 
reporting or planning to rely on controls for the related assertions. 
These commenters and others suggested that placing the proposed 
requirement for obtaining an understanding of the specialist's work in 
AS 2110 would better link the requirement to the auditor's risk 
assessment procedures, thereby reducing the likelihood that auditors 
would consider only the factors in proposed AS 1105.B2 and fail to 
consider other relevant factors set forth in AS 2110.
    The Board considered these comments and is adopting the requirement 
substantially as proposed, but relocating the requirement to AS 2110 as 
suggested by certain commenters.\57\ The procedure builds upon a 
requirement in existing AS 1210 that the auditor obtain an 
understanding of the nature of the work performed or to be performed by 
a specialist,\58\ but is more closely aligned with the required risk 
assessment procedures in AS 2110. The required procedure is important 
because it informs the auditor's evaluation of the work of the 
company's specialist, and not merely the assessment of the specialist's 
objectivity.
---------------------------------------------------------------------------

    \57\ Specifically, the requirements are located in AS 2110.28A, 
as adopted.
    \58\ See existing AS 1210.09.
---------------------------------------------------------------------------

    Placing the requirement for obtaining an understanding of the 
specialist's work and report(s), or equivalent communication, in AS 
2110, and framing the required procedure as a risk assessment 
procedure, provides better direction regarding the necessary audit 
effort for the procedure. The necessary audit effort for performing 
this procedure is governed primarily by the general requirements in AS 
2110 for obtaining a sufficient understanding of the company's internal 
control over financial reporting.\59\ This includes consideration of 
whether the auditor plans to use the specialist's work as audit 
evidence.
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    \59\ See AS 2110.18, which provides that the auditor should 
obtain a sufficient understanding of each component of internal 
control over financial reporting to: (1) Identify the types of 
potential misstatements, (2) assess the factors that affect the 
risks of material misstatement, and (3) design further audit 
procedures. See also AS 2110.19, which further provides that the 
nature, timing, and extent of procedures that are necessary to 
obtain an understanding of internal control depend on the size and 
complexity of the company; the auditor's existing knowledge of the 
company's internal control over financial reporting; the nature of 
the company's controls, including the company's use of IT; the 
nature and extent of changes in systems and operations; and the 
nature of the company's documentation of its internal control over 
financial reporting. In addition, AS 2110.20 provides that obtaining 
an understanding of internal control includes evaluating the design 
of controls that are relevant to the audit and determining whether 
the controls have been implemented.
---------------------------------------------------------------------------

    While the requirement, as adopted, likely will not represent a 
major change in practice, particularly for those firms whose practices 
already go beyond existing PCAOB standards, it should prompt auditors 
to appropriately consider the interaction of the specialist's work and 
the company's related processes and controls. For example, under the 
final amendments, the auditor should obtain an understanding of 
controls for using the work of specialists that are relevant to the 
audit, including evaluating the design of those controls and 
determining whether those controls have been implemented.\60\
---------------------------------------------------------------------------

    \60\ AS 2110.34 provides additional direction for determining 
controls relevant to the audit.
---------------------------------------------------------------------------

Comparison With Standards of Other Standard Setters

    The requirements in ISA 500 and AU-C 500 have some commonality with 
the requirements in the final amendments. Paragraph 8(b) of ISA 500 
states that, if information to be used as audit evidence has been 
prepared using the work of a management's expert, the auditor shall, to 
the extent necessary and having regard to the significance of that 
expert's work for the auditor's purposes, obtain an understanding of 
the work of that expert.
    AU-C Section 500 contains requirements that are similar to those in 
ISA 500.

Assessing the Knowledge, Skill, and Ability of the Company's Specialist 
and the Specialist's Relationship to the Company

See AS 1105.A3-.A5, as Adopted
    The final amendments set forth requirements similar to existing AS 
1210 for evaluating the knowledge, skill, and ability of the specialist 
and the relationship of the specialist to the company.\61\
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    \61\ Existing AS 1210.08 and AS 1210.10-.11 require the auditor 
to evaluate the professional qualifications of a specialist and the 
relationship of a specialist to the company.
---------------------------------------------------------------------------

Knowledge, Skill, and Ability

    The Proposal set forth a requirement similar to that in existing AS 
1210 for evaluating the professional qualifications of the specialist 
and generally provided the same factors for the auditor's assessment of 
the specialist's knowledge, skill, and ability.\62\
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    \62\ Existing AS 1210.08 provides that the auditor should 
consider certain information in evaluating the professional 
qualifications of the specialist to determine that the specialist 
possesses the necessary skill or knowledge in the particular field. 
The information to be considered in that evaluation is: (1) The 
professional certification, license, or other recognition of the 
competence of the specialist in his or her field, as appropriate; 
(2) the reputation and standing of the specialist in the views of 
peers and others familiar with the specialist's capability or 
performance; and (3) the specialist's experience in the type of work 
under consideration.

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[[Page 13454]]

    The Proposal differed from existing AS 1210, however, in certain 
respects. First, the Proposal extended the required understanding to 
expressly include the entity that employs the specialist, if the 
specialist is not employed by the company. Second, the Proposal 
expressly referred to the specialist's ``level'' of knowledge, skill, 
and ability. As with the auditor's assessment of competence under AS 
2605, Consideration of the Internal Audit Function, this approach 
recognized that specialists may possess varying degrees of knowledge, 
skill, and ability. Third, the Proposal provided that the necessary 
evidence to assess the level of knowledge, skill, and ability of the 
company's specialist would depend on (1) the significance of the 
specialist's work to the auditor's conclusion regarding the relevant 
assertion and (2) the risk of material misstatement of the relevant 
assertion. Under this approach, the persuasiveness of the evidence the 
auditor would need to obtain increases as the significance of the 
specialist's work to the auditor's conclusion or the risk of material 
misstatement of the relevant assertion increases.\63\
---------------------------------------------------------------------------

    \63\ Illustrative examples on the application of these factors 
when testing and evaluating the work of a company's specialist 
appear in the discussion on determining the necessary audit effort 
under AS 1105.A7, as provided below.
---------------------------------------------------------------------------

    The Board is adopting the requirement for evaluating the 
professional qualifications of the specialist as proposed. Most 
commenters on this aspect of the Proposal acknowledged the need for the 
auditor to obtain an understanding of and assess the knowledge, skill, 
and ability of a company's specialist. One commenter asserted that the 
proposed requirement was not well-suited to assessing the 
qualifications of the entity that employs the specialist. The Board 
considered this comment and notes that the final requirement retains 
the concept in existing AS 1210 that a specialist may be an individual 
or an entity. Accordingly, auditors should be familiar with assessing 
the qualifications of entities that are specialists or employ 
specialists. Furthermore, a strong reputation and standing of the 
specialist's employer in the specialized field can be a signal that the 
employer maintains qualified staff. On the other hand, an employer with 
a poor reputation or little expertise in the specialized field can 
indicate that more scrutiny of the qualifications of the individual 
specialist is warranted.
    Some commenters asked for more direction on how to obtain an 
understanding of the professional qualifications of the company's 
specialist and the entity that employs the specialist (for example, by 
including in the rule text the discussion from the proposing release of 
potential sources of information about a specialist's qualifications). 
One of these commenters asserted that there are practical limits on 
obtaining evidence related to a company-engaged specialist's 
competence.
    The Board considered these comments, but notes that the final 
requirement is similar to a requirement in existing AS 1210. Outreach 
to audit firms suggests that firms have policies and procedures for 
evaluating the qualifications of specialists, whether individuals or 
entities. Auditors should therefore be familiar with the process of 
assessing the knowledge, skill, and ability of entities that employ 
specialists.
    As with existing AS 1210, the final amendments do not set forth 
specific steps to perform in assessing the specialist's knowledge, 
skill, and ability. It is not practicable to provide detailed direction 
in this area because of the variety of types of specialists that may be 
encountered. Examples of potential sources of information that, if 
available, could be relevant to the auditor's evaluation include:
     Information contained within the audit firm related to the 
professional qualifications and reputation of the specialist or the 
entity that employs the specialist (if other than the company) in the 
relevant field and experience with previous work of the specialist;
     Professional or industry associations and organizations, 
which may provide information regarding: (1) Qualification 
requirements, technical performance standards, and continuing 
professional education requirements that govern their members; (2) the 
specialist's education and experience, certification, and license to 
practice; and (3) recognition of, or disciplinary actions taken 
against, the specialist;
     Discussions with the specialist, through the company, 
about matters such as the specialist's understanding of the financial 
reporting framework, the specialist's experience in performing similar 
work, and the methods and assumptions used in the specialist's work the 
auditor plans to evaluate;
     Information obtained as part of audit planning, when 
obtaining an understanding of the company's processes and identifying 
controls for testing;
     Information included in the specialist's report about the 
specialist's professional qualifications (e.g., a biography or resume);
     Responses to questionnaires provided to the specialist 
regarding the specialist's professional credentials; and
     Published books or papers written by the specialist.
    Requirements applicable to a specialist pursuant to legislation or 
regulation also could help inform the auditor's assessment of the 
specialist's knowledge, skill, and ability.
    Some of the examples listed above may provide more persuasive 
evidence than others.\64\ For example, relevant information from a 
source not affiliated with the company or specialist, the auditor's 
experience with previous work of the specialist, or multiple sources 
generally would provide more persuasive evidence than evidence from the 
specialist's uncorroborated representations about his or her 
professional credentials. Additionally, the reliability (and thus 
persuasiveness) of information about the specialist's credentials and 
experience increases when the company has effective controls over that 
information, e.g., in conjunction with controls over the selection of 
qualified specialists.
---------------------------------------------------------------------------

    \64\ As previously discussed, the risk of material misstatement 
of the relevant assertion and the significance of the specialist's 
work to the auditor's conclusion regarding the relevant assertion 
affect the persuasiveness of the evidence needed with respect to the 
knowledge, skill, and ability of the company's specialist.
---------------------------------------------------------------------------

    Some commenters asked for clarification as to how the company's 
controls and processes for using the work of a company's specialist 
should be considered when performing the assessment of knowledge, 
skill, and ability. As discussed earlier, the interaction of the 
specialist's work and the company's processes should be considered by 
the auditor in assessing and responding to risk in the related accounts 
and disclosures, especially when the specialist's work is significant 
to the auditor's conclusion regarding the relevant assertion and the 
accounts or disclosures have higher risk. Therefore, the company's 
controls and processes are considered in identifying and appropriately 
assessing the risks of material misstatement of the relevant assertion, 
which is one of the two factors that the auditor considers under AS 
1105.A5, as adopted, in determining the necessary evidence for 
assessing the specialist's level of knowledge, skill, and ability.

[[Page 13455]]

Relationship to the Company

    The Proposal provided that the auditor would assess the 
relationship to the company of the specialist and the entity that 
employs the specialist (if other than the company)--specifically, 
whether circumstances exist that give the company the ability to 
significantly affect the specialist's judgments about the work 
performed, conclusions, or findings (e.g., through employment, 
financial, ownership, or other business relationships, contractual 
rights, family relationships, or otherwise). The proposed requirement 
was similar to existing AS 1210.10, but expanded the list of matters 
that the auditor should consider to include financial and business 
relationships with the company.
    The Board is adopting this requirement substantially as proposed, 
with the addition of a note that sets forth examples of potential 
sources of information that could be relevant to the auditor's 
assessment.
    Some commenters supported the proposed requirement for the auditor 
to assess the specialist's relationship to the company and stated that 
it was appropriate. Two commenters, however, asserted that there could 
be practical challenges to assessing the relationship to the company of 
the entity that employs the specialist (e.g., if the entity that 
employs the specialist lacks systems to track such relationships or the 
auditor does not have access to those systems). The Board considered 
these comments, but notes that existing AS 1210 already requires an 
evaluation of the relationship of the specialist, whether an individual 
or an entity, to the client. Outreach to audit firms suggests that 
firms have policies and procedures for evaluating the objectivity of 
specialists, whether individuals or entities. Therefore, auditors 
should be familiar with assessing the qualifications of entities that 
are specialists or employ specialists.
    Other commenters asked for additional direction regarding the 
necessary effort to obtain information regarding the specialist's 
relationship to the company. One commenter also emphasized the 
importance of considering ethical and performance requirements 
promulgated by a specialist's profession or by legislation or 
regulation governing the specialist. The final amendments do not 
prescribe specific steps to perform in assessing the specialist's 
relationship to the company, because additional specificity would make 
the requirements unnecessarily prescriptive. The Board has added a note 
to the final requirement, however, that includes non-exclusive examples 
of potential sources of information that could be relevant to the 
auditor's assessment of the relationship to the company of both the 
specialist and the specialist's employer (if other than the 
company).\65\ These examples include disclosures by the specialist 
about relationships with the company in the specialist's report, or 
equivalent communication, pursuant to requirements promulgated by the 
specialist's profession or by legislation governing the specialist.\66\ 
As with the auditor's assessment of a specialist's knowledge, skill, 
and ability, certain sources of information may provide more persuasive 
evidence than others. In situations where more persuasive evidence is 
required under these requirements, it may be appropriate to perform 
procedures to obtain evidence from multiple sources.
---------------------------------------------------------------------------

    \65\ See note to AS 1105.A4, as adopted. These examples were 
based on examples set forth in the Proposal, but have been refined 
to better reflect their application in practice.
    \66\ While the Proposal had suggested that information regarding 
such requirements could be relevant to the auditor's evaluation of 
the specialist's relationships to the company, disclosures about 
relationships pursuant to such requirements are more relevant to the 
auditor's assessment than merely information about the legal or 
professional requirements.
---------------------------------------------------------------------------

    Some commenters also expressed a preference for retaining the term 
``objectivity'' with respect to a company's specialist and further 
acknowledging that objectivity may exist along a spectrum. Similar to 
the Proposal, the final amendments reserve the term ``objectivity'' for 
specialists engaged by the auditor to assist in obtaining and 
evaluating audit evidence. The work of a company's specialist is 
different in nature from the work of an auditor's specialist, since a 
company's specialist performs work that the company frequently uses as 
source material for one or more financial statement accounts or 
disclosures, including accounting estimates. With respect to the 
existence of objectivity along a spectrum, the final amendments 
recognize that a company's ability to significantly affect a 
specialist's judgment may vary and, as discussed below, provide a 
spectrum for evaluating the company's ability to significantly affect 
the specialist's judgments.
    As was proposed, the final amendments provide that, if the auditor 
identifies relationships between the company and the specialist (or the 
specialist's employer, if other than the company), the auditor has a 
responsibility to assess whether the company has the ability to 
significantly affect the specialist's judgments about the work 
performed, conclusions, or findings.\67\ Examples of the types of 
circumstances that might give the company the ability to affect the 
specialist's judgments include, but are not limited to:
---------------------------------------------------------------------------

    \67\ See AS 1105.A4, as adopted.
---------------------------------------------------------------------------

     The reporting relationship of a company-employed 
specialist within the company;
     Compensation of a company's specialist based, in part, on 
the outcome of the work performed;
     Relationships a company-engaged specialist has with 
entities acting as an agent of the company;
     Personal relationships, including family relationships, 
between the company's specialist and others within company management;
     Financial interests, including stock holdings, company 
specialists have in the company; and
     Ownership, business relationships, or other financial 
interests the employer of a company-engaged specialist has with respect 
to the company.
    The auditor's assessment that the company has the ability to 
influence the specialist, however, does not preclude the auditor from 
using the work of a company's specialist, whether employed or engaged, 
as audit evidence. Rather, consistent with existing AS 1210, it is a 
factor in determining the necessary audit effort to evaluate that 
specialist's work.\68\ In general, the necessary audit effort increases 
as the company's ability to affect the specialist's judgments 
increases.
---------------------------------------------------------------------------

    \68\ See AS 1105.A7-.A10, as adopted. Examples that illustrate 
how relationships between the company and the company's specialist 
can affect the necessary audit effort in evaluating the work of a 
company's specialist under the final amendments appear in the 
discussion on determining the necessary evidence, as provided below.
---------------------------------------------------------------------------

Determining the Necessary Evidence

    The Proposal differed from existing AS 1210 in that it set forth 
scalable requirements for determining the necessary evidence for 
evaluating both the knowledge, skill, and ability of the specialist and 
the relationship of the specialist to the company. The Board is 
adopting these requirements as proposed. Under the final amendments, 
the necessary evidence to assess the level of knowledge, skill, and 
ability of the company's specialist and the specialist's relationship 
to the company depends on (1) the significance of the specialist's work 
to the auditor's conclusion regarding the relevant assertion and (2) 
the risk of material misstatement of the relevant assertion. As the 
significance of the specialist's

[[Page 13456]]

work and risk of material misstatement increases, the persuasiveness of 
the evidence the auditor should obtain for those assessments also 
increases.\69\
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    \69\ See AS 1105.A5, as adopted.
---------------------------------------------------------------------------

    No commenters opposed the proposed framework for determining the 
necessary evidence. A number of commenters, however, asked for 
clarification on the application of the requirement when performing the 
relevant evaluations. The Board's analysis of these comments is 
discussed above in connection with the required evaluations of the 
specialist's knowledge, skill, and ability, and the relationship of the 
specialist to the company.

Comparison With Standards of Other Standard Setters

    Paragraph 8(a) of ISA 500 provides that, if information to be used 
as audit evidence has been prepared using the work of a management's 
expert, the auditor shall, to the extent necessary and having regard to 
the significance of that expert's work for the auditor's purposes, 
evaluate the competence, capabilities, and objectivity of that expert.
    AU-C Section 500 contains requirements that are similar to those in 
ISA 500.

Evaluating the Work of the Company's Specialist

See AS 1105.A6-.A10, as Adopted
    In general, a specialist's work involves using data, assumptions, 
and methods. The auditor's responsibilities under existing AS 1210 with 
respect to the data, assumptions, and methods used by the specialist 
are limited to (a) obtaining an understanding of the methods and 
assumptions used by the specialist and (b) making appropriate tests of 
data provided to the specialist.\70\ In addition, the auditor should 
evaluate whether the specialist's findings support the related 
assertions in the financial statements.\71\ Ordinarily, the auditor 
would use the work of the specialist unless the auditor's procedures 
lead the auditor to believe the findings are unreasonable in the 
circumstances.\72\ If the auditor believes the specialist's findings 
are unreasonable, he or she is required to apply additional procedures, 
which may include potentially obtaining the opinion of another 
specialist.\73\ Notably, before the final amendments, PCAOB standards 
have not expressly addressed how to determine the necessary audit 
effort to be applied in performing those procedures.
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    \70\ For fair value measurements, however, another standard 
requires the auditor to evaluate the reasonableness of significant 
assumptions of the specialist. See footnote 2 of AS 2502. This 
standard is being superseded in the Estimates Release, supra note 
20.
    \71\ See existing AS 1210.12.
    \72\ Id.
    \73\ Id.
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    The Proposal sought to enhance the requirements for testing and 
evaluating the work of the company's specialist by:
     Extending the auditor's responsibilities for evaluating 
the specialist's assumptions to include all significant assumptions 
used by the specialist (not just those used in fair value 
measurements);
     Expanding the auditor's responsibilities with respect to 
data to include evaluating external data used by the specialist (not 
just data provided by the company to the specialist);
     Adding a requirement for the auditor to evaluate the 
appropriateness of the methods used by the specialist, including 
whether the data was appropriately applied;
     Setting forth a requirement for the auditor to comply with 
the Board's proposed estimates standard \74\ when the auditor tests 
management's process for developing an estimate and a company's 
specialist was used; and
---------------------------------------------------------------------------

    \74\ See Proposed Auditing Standard--Auditing Accounting 
Estimates, Including Fair Value Measurements and Proposed Amendments 
to PCAOB Auditing Standards, PCAOB Release No. 2017-002 (June 1, 
2017).
---------------------------------------------------------------------------

     Providing direction for determining the necessary audit 
effort for testing and evaluating the specialist's work, based on the 
risk of material misstatement and other factors set forth in the 
standard.
    Commenters expressed mixed views on the premise underlying the 
Proposal that the auditor should test and evaluate the work of a 
company's specialist. While a number of commenters supported that 
premise, other commenters opposed expanding the auditor's 
responsibilities with respect to the specialist's methods and 
assumptions beyond existing AS 1210. Some of these commenters expressed 
concerns that the auditor may not be qualified to evaluate the work of 
a specialist and recommended retaining the more limited audit approach 
reflected in existing AS 1210, including the statement that ``the 
auditor is not expected to have the expertise of a person trained for 
or qualified to engage in practice of another profession or 
occupation.''
    A number of commenters also addressed specific aspects of the 
proposed requirements for testing and evaluating the work of company 
specialists. Some commenters questioned the proposal's general use of 
the term ``test'' in describing the auditor's responsibilities, as well 
as the proposed requirement to also comply with the proposed estimates 
standard in circumstances where the auditor tests management's process 
for developing an estimate and a company's specialist was also used. 
Those commenters asserted that the expected audit effort was unclear. 
Two commenters stated that the proposed requirements in this area could 
be interpreted as requiring reperformance of the specialist's work, 
which one of these commenters asserted would be beyond the expertise of 
most auditors and thus require auditors to use an auditor's specialist.
    In addition, some commenters requested clarification on the 
expectations for evaluating a specialist's models, especially in 
situations where auditors are unable to gain access to proprietary 
models used by company-engaged specialists. Some commenters also 
expressed concern about the proposed requirement to evaluate whether 
data was appropriately used by the specialist. Some of these commenters 
asserted that this requirement appeared to require auditors to 
reperform the specialist's work and suggested clarifying or eliminating 
that requirement. Additionally, some commenters suggested allowing 
auditors to rely on the issuer's controls over the use of specialists 
in determining the necessary procedures for evaluating the specialist's 
work.
    A number of commenters acknowledged that the proposed requirements 
were intended to be scalable. However, some commenters questioned 
whether they would be scalable in practice. Other commenters asked for 
guidance on tailoring audit procedures based on risk and the other 
factors set forth in the Proposal, especially procedures under the 
proposed requirement to also comply with the proposed estimates 
standard. Also, some commenters asserted that the requirements did not 
adequately distinguish the audit effort based on whether the specialist 
was engaged or employed by the company.
    After considering the comments on the Proposal, the Board is 
retaining the fundamental approach in the Proposal--under which the 
auditor evaluates the data, significant assumptions, and methods used 
by the specialist. This approach is intended to increase audit 
attention on the work of a company's specialist, particularly when that 
work is significant in areas of higher risk, to increase the likelihood 
that the auditor would detect material financial

[[Page 13457]]

statement misstatements related to that work.
    Taking into account comments on specific aspects of the proposed 
requirements, however, the final amendments reflect a number of 
clarifying revisions to eliminate or revise certain proposed 
requirements that may have been perceived by commenters as 
unnecessarily complex or prescriptive. The revisions address concerns 
expressed by certain commenters, while preserving the intended benefits 
of the final amendments, and include:
     Removing the word ``test'' from the requirements to 
evaluate the work of the company's specialist, except in relation to 
company-produced data; and
     Reframing the requirements for evaluating the data, 
significant assumptions, and methods used by the specialist to describe 
the key considerations in making those evaluations.
    In addition, the final amendments clarify the applicability of the 
requirements in circumstances when the company's specialist is involved 
in developing an accounting estimate, such as developing assumptions 
and methods used in an accounting estimate. In such circumstances, the 
requirements in Appendix A of AS 1105 apply to evaluating the data, 
significant assumptions,\75\ and methods developed (or generated) by 
the specialist, or sourced by the specialist from outside the company, 
as well as to testing company-produced data. In contrast, for 
significant assumptions provided by management to the specialist, the 
auditor is required to look to the requirements in AS 2501, as adopted. 
The final amendments are discussed in more detail below.
---------------------------------------------------------------------------

    \75\ A footnote to AS 1105.A8, as adopted, refers the auditor to 
AS 2501.15, as adopted, for the procedures to perform when 
identifying significant assumptions. For purposes of identifying 
significant assumptions, the company's assumptions include 
assumptions developed by the company's specialist.
---------------------------------------------------------------------------

Evaluating the Specialist's Work: Data, Significant Assumptions, and 
Methods

See AS 1105.A6 and .A8, as Adopted
    The revisions reflected in the final amendments clarify the 
auditor's responsibilities for evaluating the work of a company's 
specialist, and are intended to avoid potential confusion that the 
auditor is required to reperform the work of the company's specialist. 
Among other things, the revised requirements reserve the use of the 
term ``test'' for procedures applied to company-produced information 
used by the specialist, consistent with its usage in AS 2501, as 
adopted.\76\
---------------------------------------------------------------------------

    \76\ See Estimates Release, supra note 20.
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    Notably, instead of requiring the auditor to comply with AS 2501, 
as adopted, the auditor would be required to apply a set of analogous 
procedures for evaluating data, significant assumptions, and methods 
that are tailored to situations in which specialists are used.\77\ For 
example, under the final amendments, the auditor's responsibilities 
with respect to data, significant assumptions, and methods used by the 
specialist generally are:
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    \77\ A note to AS 1105.A6, as adopted, emphasizes that 
paragraphs .16-.17 of AS 2101 describe the auditor's 
responsibilities for determining whether specialized knowledge or 
skill is needed. This includes determining whether an auditor's 
specialist is needed to evaluate the work of a company's specialist.
---------------------------------------------------------------------------

     Company-produced data: Test the accuracy and completeness 
of company-produced data used by the specialist (see AS 1105.A8a, as 
adopted); \78\
---------------------------------------------------------------------------

    \78\ See also AS 1105.10 for procedures when the auditor uses 
information produced by the company as audit evidence.
---------------------------------------------------------------------------

     Data from sources external to the company: Evaluate the 
relevance and reliability of the data from sources external to the 
company that are used by the specialist (see AS 1105.A8a, as adopted);
     Significant assumptions: Evaluate whether the significant 
assumptions used by the specialist are reasonable:
    (1) Assumptions developed by the specialist: Taking into account 
the consistency of those assumptions with relevant information (see AS 
1105.A8b(1), as adopted);
    (2) Assumptions provided by company management and used by the 
specialist: Looking to the requirements set forth in AS 2501.16-.18, as 
adopted (see AS 1105.A8b(2), as adopted);
    (3) Assumptions based on the company's intent and ability to carry 
out a particular course of action: Looking to the requirements set 
forth in AS 2501.17, as adopted (see AS 1105.A8b(3), as adopted); and
     Methods: Evaluate whether the methods used by the 
specialist are appropriate under the circumstances, taking into account 
the requirements of the applicable financial reporting framework (see 
AS 1105.A8c, as adopted).
    Under the final amendments, the focus of the auditor's evaluation 
of the work of the company's specialist does not require reperforming 
the specialist's work or evaluating whether the work complies with all 
technical aspects in the specialist's field. Instead, the auditor's 
responsibility is to evaluate whether the specialist's work provides 
sufficient appropriate evidence to support a conclusion regarding 
whether the corresponding accounts or disclosures in the financial 
statements are in conformity with the applicable financial reporting 
framework.
    With respect to the specialist's methods, the auditor's 
responsibilities under PCAOB standards have historically been to 
understand the method used. The final amendments extend that obligation 
to encompass evaluating whether the method is appropriate under the 
circumstances, taking into account the requirements of the applicable 
financial reporting framework.\79\ In many cases, evaluating a method's 
conformity with the applicable financial reporting requirements is the 
same as evaluating its appropriateness under the circumstances (e.g., 
if the applicable accounting standard requires a particular method for 
determining the estimate). However, if the applicable financial 
reporting framework allows more than one method, or if the appropriate 
method under the framework depends on the circumstances, evaluating 
conformity with the framework involves consideration of other relevant 
factors, such as, the nature of the estimate and the auditor's 
understanding of the company and its environment.
---------------------------------------------------------------------------

    \79\ See AS 1105.A8c, as adopted.
---------------------------------------------------------------------------

    A note to the final amendments also clarifies that evaluating the 
specialist's methods includes assessing whether the data and 
significant assumptions are appropriately applied under the applicable 
financial reporting framework.\80\ Evaluating the application of the 
data encompasses, for example, whether the data is selected and 
adjusted in conformity with the requirements of the applicable 
financial reporting framework. Similarly, evaluating the application of 
significant assumptions encompasses evaluating whether the assumptions 
were selected in conformity with the requirements of the applicable 
financial reporting framework.
---------------------------------------------------------------------------

    \80\ See note to AS 1105.A8c, as adopted.
---------------------------------------------------------------------------

    The final amendments do not require the auditor to obtain access to 
proprietary models used by the specialist. Rather, the auditor's 
responsibility is to obtain information to assess whether the model is 
in conformity with the applicable financial reporting framework. 
Depending on the model and the factors set forth in AS 1105.A7, as 
adopted, this might involve, for example, obtaining an understanding of 
the model, reviewing descriptions of

[[Page 13458]]

the model in the specialist's report or equivalent communication, 
testing controls over the company's evaluation of the specialist's 
work, or assessing the inputs to and output from the model (if 
necessary, using an alternative model for comparison).
    With respect to the specialist's significant assumptions, auditors 
have historically had an obligation under PCAOB standards to understand 
the assumptions \81\ and, for fair value measurements, to evaluate the 
reasonableness of the assumptions.\82\ The final amendments extend the 
auditor's obligation to include evaluating the reasonableness of 
significant assumptions used by the specialist. This involves comparing 
the assumptions to relevant information. The note accompanying AS 
1105.A8b(1), as adopted, provides examples of information that, if 
relevant, should be taken into account: (1) Assumptions generally 
accepted within the specialist's field; (2) supporting information 
provided by the specialist; (3) industry, regulatory, and other 
external factors, including economic conditions; (4) the company's 
objectives, strategies, and related business risks; (5) existing market 
information; (6) historical or recent experience, along with changes in 
conditions and events affecting the company; and (7) significant 
assumptions used in other estimates tested in the company's financial 
statements. These examples--including examples (1) and (2), which were 
suggested by commenters--point to information that generally would be 
available to the auditor (e.g., through other procedures performed on 
the audit or the auditor's knowledge or the company and its industry).
---------------------------------------------------------------------------

    \81\ See existing AS 1210.09.
    \82\ See footnote 2 of AS 2502.
---------------------------------------------------------------------------

    Furthermore, the final amendments provide that, if a significant 
assumption is provided by company management and used by the 
specialist, the auditor should look to the requirements in AS 
2501.16-.18, as adopted. The final amendments also provide that, if a 
significant assumption is based on the company's intent and ability to 
carry out a particular course of action, the auditor should look to the 
requirements set forth in AS 2501.17, as adopted. This applies 
regardless of whether the significant assumption was developed by the 
company or the company's specialist.

Determining the Necessary Audit Effort for Evaluating the Specialist's 
Work

See AS 1105.A7, as Adopted
    Similar to the Proposal, the final amendments set forth four 
factors that affect the necessary evidence from the auditor's 
evaluation of the specialist's work to support a conclusion regarding a 
relevant assertion. Specifically, under the final amendments, the 
necessary evidence depends on the: (1) Significance of the specialist's 
work to the auditor's conclusion regarding the relevant assertion; (2) 
risk of material misstatement of the relevant assertion; (3) level of 
knowledge, skill, and ability of the specialist; \83\ and (4) the 
ability of the company to significantly affect the specialist's 
judgments about the work performed, conclusions, or findings.
---------------------------------------------------------------------------

    \83\ As noted previously, this factor includes consideration of 
professional requirements the specialist is required to follow.
---------------------------------------------------------------------------

    Some commenters asked for additional clarification or direction on 
how to apply the four factors to determine the necessary audit effort 
for evaluating the specialist's work. One commenter requested that the 
Board elaborate upon certain terms (e.g., terms ``extensively'' and 
``less extensive procedures'') that were used in two of the three 
examples that were included in the Proposal to illustrate how certain 
factors could affect the necessary audit effort in evaluating the work 
of a company's specialist. Another commenter requested that the Board 
provide additional examples of less complex scenarios.
    In addition, some commenters asserted that the Proposal did not 
adequately account for differences between company-employed and 
company-engaged specialists. These commenters stated that the nature 
and extent of an auditor's procedures with respect to the work of a 
company-engaged specialist with the necessary knowledge, skill, and 
objectivity should not necessarily be the same as those for the work of 
a company-employed specialist. One commenter suggested expressly 
including in the list of factors performance standards that the 
specialist is required to follow.
    The requirements regarding determining the necessary audit effort 
for evaluating the specialist's work were adopted substantially as 
proposed. The changes to the procedural requirements for evaluating the 
data, significant assumptions, and methods used by the specialist 
should help address concerns about the necessary level of effort under 
the appendix. Also, the three examples included in the Proposal have 
been revised to align with the final amendments and expanded to address 
factors that lead to more or less audit attention and illustrate how 
the additional attention may be directed under the circumstances.
    With respect to the distinction between company-employed and 
company-engaged specialists, the Board believes that the final 
amendments provide an appropriate framework for distinguishing the work 
effort when using the work of such specialists. In particular, one of 
the four factors related to determining the necessary audit effort is 
the ability of the company to significantly affect the specialist's 
judgments about the work performed, conclusions, or findings. This 
factor is discussed in more detail above.
    Specifically, under the four factors set forth in the final 
amendments, the auditor should obtain more persuasive evidence as the 
significance of the specialist's work, the risk of material 
misstatement, or the ability of the company to affect the specialist's 
judgments increases, or as the level of knowledge, skill, and ability 
possessed by the specialist decreases. In general, the required audit 
effort when evaluating the work of a company's specialist would be 
greatest when the risk of material misstatement is high; the 
specialist's work is critical to the auditor's conclusion; the 
specialist has a lower level of knowledge, skill, and ability in the 
particular field; and the company has the ability to significantly 
affect the specialist's judgments. These factors are also illustrated 
in Figure 4, below.

[[Page 13459]]

[GRAPHIC] [TIFF OMITTED] TN04AP3.004

    Under the final amendments, the first two factors, in combination, 
relate to the persuasiveness of the evidence needed from the work of 
the company's specialist, as follows:
     Risk of Material Misstatement. Consistent with the risk 
assessment standards, under the final amendments, the higher the risk 
of material misstatement for an assertion, the more persuasive the 
evidence needed to support a conclusion about that assertion.\84\ 
Pursuant to existing PCAOB standards, tests of controls are required if 
the risk of material misstatement is based on reliance on controls.\85\
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    \84\ See paragraph .09a of AS 2301.
    \85\ See AS 2301.16, which addresses testing controls to modify 
the nature, timing, and extent of planned substantive procedures.
---------------------------------------------------------------------------

     Significance of the Specialist's Work. The significance of 
the specialist's work refers to the degree to which the auditor would 
use the work of the company's specialist to support the auditor's 
conclusions about the assertion. Generally, the greater the 
significance of the specialist's work to the auditor's conclusion 
regarding the relevant assertion, the more persuasive the evidence from 
the specialist's work needs to be. The significance of the specialist's 
work stems from:
     The extent to which the specialist's work affects 
significant accounts and disclosures in the financial statements. In 
some situations, the specialist's work might be used only as a 
secondary check for a significant account or disclosure, while in other 
situations that work might be a primary determinant in one or more 
significant accounts and disclosures in the financial statements.
     The auditor's approach to testing the relevant assertion. 
When a company's accounting estimate is determined principally based on 
the work of a company's specialist, an auditor testing the company's 
process for developing the accounting estimate would plan to use the 
work of the company's specialist for evidence regarding the estimate. 
On the other hand, if the auditor tests an assertion by developing an 
independent expectation, the auditor would give less consideration to 
the work of the company's specialist.\86\
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    \86\ As another example, the auditor might develop an 
independent expectation using certain assumptions or methods of the 
company's specialist. In those instances, the auditor's evaluation 
would focus on those assumptions or methods that the auditor used in 
developing his or her independent expectation.
---------------------------------------------------------------------------

    The other two factors--the specialist's level of knowledge, skill, 
and ability, and the ability of the company to significantly affect the 
specialist's judgments--relate to the degree of reliability of the 
specialist's work as audit evidence (i.e., the extent to which the 
specialist's work could provide persuasive evidence, if relevant and 
found to be satisfactory after the auditor's evaluation).
    In some situations, if the auditor has doubt about the specialist's 
knowledge, skill, and ability or about the company's effect on the 
specialist's judgments, the auditor might choose not to use the work of 
the company's specialist, instead of performing additional procedures 
with respect to evaluating the specialist's work. The final amendments 
do not preclude the auditor from pursuing other alternatives to using 
that specialist's work. Such alternatives might include developing an 
independent expectation of the related accounting estimate or seeking 
to use the work of another specialist.
    The following examples illustrate various ways in which the factors 
discussed above can affect the necessary audit effort in evaluating the 
work of a company's specialist under the final amendments. The examples 
assume that the auditor will evaluate, as appropriate, the data, 
significant assumptions, and

[[Page 13460]]

methods used by the specialist, and evaluate the relevance and 
reliability of the work of the company's specialist and its 
relationship to the relevant assertion.

    Example 1--An oil and gas production company employs an 
experienced petroleum reserve engineer to assist in developing the 
estimated proved oil and gas reserves \87\ that are used in multiple 
financial statement areas, including: (1) The company's impairment 
analysis; (2) depreciation, depletion and amortization calculations; 
and (3) related financial statement disclosures, such as reserve 
disclosures. A substantial portion of the engineer's compensation is 
based on company earnings, and the engineer has a reporting line to 
the company's chief financial officer. The auditor concludes that 
the risk of material misstatement of the valuation of oil and gas 
properties is high, and the reserve engineer's work is significant 
to the auditor's conclusion regarding the assertion. Thus, the 
auditor would need to obtain more persuasive audit evidence 
commensurate with a high risk of material misstatement, devoting 
more audit attention to the data, significant assumptions, and 
methods that are more important to the specialist's findings and 
more susceptible to error or significant management influence. On 
the other hand, relatively less audit evidence might be needed for 
the work of an individual reserve engineer if the company has 
several properties of similar risk, and the reserve studies are 
performed by different qualified reserve engineers who are either 
(1) engaged by the company, having no significant ties that give the 
company significant influence over the specialists' judgments or (2) 
employed specialists for which the company has implemented 
compensation policies, reporting lines, and other measures to 
prevent company management from having significant influence over 
the specialists' judgments.
---------------------------------------------------------------------------

    \87\ See Rule 4-10(a)(22) of Regulation S-X, 17 CFR 210.4-
10(a)(22).
---------------------------------------------------------------------------

    Example 2--A financial services company specializes in 
residential mortgage and commercial mortgage loans, which are either 
sold or held in its portfolio. During the financial statement audit, 
the auditor may inspect appraisals prepared by the company's 
specialists for the real estate collateralizing loans for a variety 
of reasons, including in conjunction with testing the valuation of 
loans and the related allowance for loan losses. Under these 
circumstances, the persuasiveness of the evidence needed from (and 
the necessary degree of audit attention devoted to evaluating the 
methods, significant assumptions, and data used in) an individual 
appraisal would depend, among other things, on the importance of the 
individual appraisal to the auditor's conclusion about the related 
financial statement assertion. In general, more audit attention 
would be needed for appraisals used in testing the valuation of 
individually large loans that are valued principally based on their 
collateral than for appraisals inspected in loan file reviews for a 
portfolio of smaller loans with a low risk of default and a low 
loan-to-value ratio.
    Example 3--A manufacturing company engages an actuary to 
calculate the projected pension benefit obligation (``PBO'') for its 
pension plan, which is used to determine the related accounts and 
disclosures in the financial statements. The auditor has assessed 
the risk of material misstatement for the valuation of the PBO as 
high and concluded that the actuary's work is significant to the 
auditor's conclusion. The actuary has extensive experience and is 
employed by a highly regarded actuarial firm with many clients. The 
actuary and actuarial firm have no relationships with the company 
other than performing the actuarial pension plan calculations for 
the company's financial statements. Under these circumstances, the 
necessary level of audit attention is less than it otherwise would 
be for a situation where a specialist has a lower level of 
knowledge, skill and ability, or the company has the ability to 
significantly affect the specialist's judgments about the work 
performed, conclusions, or findings. When more audit attention is 
needed, the auditor would focus on those aspects of the specialist's 
work that could be affected by the issues related to the 
specialist's knowledge, skill, and ability or by the company's 
ability to significantly affect the specialist's judgments.

    The three examples above are provided only to illustrate the 
auditor's consideration of the four factors set forth in the final 
amendments when determining the necessary audit effort for evaluating 
the work of the company's specialist. Differences in circumstances, or 
additional information, could lead to different conclusions. The 
examples are not intended to prescribe the specific procedures to be 
performed in evaluating the work of a company's specialist in any 
particular situation, which should be determined in accordance with the 
final amendments.

Evaluating the Specialist's Work: Findings

See AS 1105.A9-.A10, as Adopted
    The Proposal set forth requirements for evaluating the relevance 
and reliability of the specialist's findings. The proposed requirements 
built upon the existing requirements to evaluate the specialist's 
findings and were aligned with the risk assessment standards.\88\ The 
Proposal also provided factors that affect the relevance and 
reliability of the specialist's work. Additionally, the proposed 
requirements described examples of situations in which additional 
procedures ordinarily are necessary. Commenters on this aspect of the 
Proposal generally supported the proposed approach. A few commenters 
asked for an explanation of the additional procedures to be performed. 
One commenter stated that certain restrictions, disclaimers, or 
limitations are common in specialists' reports and that auditors may 
have no choice but to accept them.
---------------------------------------------------------------------------

    \88\ Existing AS 1210.12 requires the auditor to evaluate 
whether the specialist's findings support the related assertions in 
the financial statements. It does not specify, however, what might 
lead an auditor to conclude that he or she should perform additional 
procedures or obtain the opinion of another specialist.
---------------------------------------------------------------------------

    After considering the comments received, the Board is adopting the 
requirements as proposed with one modification discussed below. The 
final requirements in AS 1105.A10, as adopted, provide that the auditor 
should perform additional procedures, as necessary, if the specialist's 
findings or conclusions appear to contradict the relevant assertion or 
the specialist's work does not provide sufficient appropriate evidence. 
The final requirements also provide examples of situations in which 
additional procedures ordinarily are necessary, such as when the 
specialist's report, or equivalent communication,\89\ contains 
restrictions, disclaimers, or limitations regarding the auditor's use 
of the report or the auditor has identified that the specialist has a 
conflict of interest relevant to the specialist's work. The final 
requirements do not prescribe specific procedures to be performed 
because the necessary procedures depend on the circumstances creating 
the need for the procedures.
---------------------------------------------------------------------------

    \89\ AS 1105.A9-.A10, as adopted, added the phrase ``or 
equivalent communication,'' which was not part of the proposed 
amendments, because a company's specialist may communicate his or 
her findings or conclusions in a memorandum or other written 
alternative to a formal report. AS 1201, Appendix C, as adopted, and 
AS 1210, as amended, refer to a specialist's report ``or equivalent 
documentation.'' The difference in terminology is intended to 
distinguish information provided by the auditor's specialist from 
information provided by the company's specialist.
---------------------------------------------------------------------------

    A specialist's report may contain restrictions, disclaimers, or 
limitations that cast doubt on the relevance and reliability of the 
information contained in the specialist's report and affect how the 
auditor can use the report of the specialist. For example, a 
specialist's report that states ``the values in this report are not an 
indication of the fair value of the underlying assets'' generally would 
not provide sufficient appropriate evidence related to fair value 
measurements. On the other hand, a specialist's report that indicates 
that the specialist's calculations were based on information supplied 
by management may still be appropriate for use by the auditor to 
support the relevant assertion, since the auditor would already be 
required to test the company-supplied data used in the specialist's 
calculations.

[[Page 13461]]

    The requirements in AS 1105.A10, as adopted, do not require the 
auditor to perform procedures specifically to search for potential 
conflicts of interest that a company's specialist might have, other 
than those resulting from the specialist's relationship with the 
company. However, the auditor may become aware of conflicts of interest 
arising from relationships with parties outside the company (e.g., 
through obtaining information about the specialist's professional 
reputation and standing, reading the specialist's report, or performing 
procedures in other audit areas). For example, in reviewing an 
appraisal of the collateral for a material loan receivable, the auditor 
may become aware that the appraiser has a substantial financial 
interest in the collateral. If the auditor becomes aware of a conflict 
of interest that could affect the specialist's judgments about the work 
performed, conclusions, or findings, the auditor would need to consider 
the effect of that conflict on the reliability of the specialist's 
work, and perform additional procedures if necessary to obtain 
sufficient appropriate evidence regarding the relevant financial 
statement assertion.

Comparison With Standards of Other Standard Setters

    Paragraph 8(c) of ISA 500 provides that, if information to be used 
as audit evidence has been prepared using the work of a management's 
expert, the auditor shall, to the extent necessary and having regard to 
the significance of that expert's work for the auditor's purposes, 
evaluate the appropriateness of that expert's work as audit evidence 
for the relevant assertion.
    AU-C Section 500 contains requirements that are similar to those in 
ISA 500.

Amendments Related to Supervising or Using the Work of an Auditor's 
Specialist

    The final amendments set forth requirements for supervising or 
using the work of an auditor's specialist, taking into account 
differences in the auditor's relationship with employed specialists and 
engaged specialists. A new appendix to AS 1201 applies to the 
supervision of auditor-employed specialists, and AS 1210, as amended, 
applies when using the work of auditor-engaged specialists.
    Commenters on the Proposal generally supported the proposed 
approach for overseeing and coordinating the work of an auditor's 
specialists, which was risk-based and set forth largely parallel 
requirements when using the work of both auditor-employed and auditor-
engaged specialists. A few commenters, however, expressed concerns with 
the practicality and clarity of certain aspects of the proposed 
requirements. These comments and others are discussed below.
Amendments to AS 1201 for Supervising the Work of an Auditor-Employed 
Specialist
    Appendix C of AS 1201, as adopted, supplements the existing 
requirements in AS 1201.05-.06 by providing more specific direction on 
applying the general supervisory principles in AS 1201 to the 
supervision of an auditor-employed specialist who assists the auditor 
in obtaining or evaluating audit evidence.

Meaning of ``Auditor-Employed Specialist''

See AS 1201.C1, as Adopted
    The Proposal used the term ``auditor-employed specialist'' to mean 
a ``specialist employed by the auditor's firm,'' consistent with 
existing requirements.\90\ Two commenters asked for clarification of 
how to apply the terms ``auditor-employed'' and ``auditor-engaged'' 
specialists when specialists are employed by entities that are 
affiliated with the audit firm and those specialists are subject to the 
same quality control policies and procedures and independence 
requirements as employees of the audit firm.
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    \90\ See existing AS 1210.05, which states that AS 1201 applies 
to situations in which ``a specialist employed by the auditor's firm 
participates in the audit.''
---------------------------------------------------------------------------

    The final amendments retain the existing concept that an ``auditor-
employed specialist'' is a ``specialist employed by the auditor's 
firm.'' Given that the terms ``auditor-employed specialist'' and 
``auditor-engaged specialist'' in the final amendments are consistent 
with existing requirements, auditors should be familiar with this 
distinction. The Board recognizes, however, that there may be instances 
where an auditor uses the work of a specialist who is a partner, 
principal, shareholder or employee of an affiliated entity that is not 
an accounting firm and treats that specialist as if he or she were 
employed by the auditor's firm (i.e., as an auditor-employed 
specialist). While it is not practicable to address all the legal 
structures or affiliations between accounting firms and specialist 
entities that may give rise to such situations, the final amendments 
are not intended to change current practice where the specialist is 
employed by an affiliated entity that adheres to the same quality 
control and independence requirements as the auditor's firm. In such 
circumstances, the Board understands that the auditor would assess the 
qualifications and independence of that specialist in the same ways as 
an engagement team member employed by the firm.

Comparison With Standards of Other Standard Setters

    ISA 620 covers the auditor's use of the work of both auditor-
employed experts and auditor-engaged experts, but the requirements in 
ISA 620 for the auditor's evaluation of the objectivity of an auditor-
employed expert differ from those for evaluating the objectivity of an 
auditor-engaged expert.
    AU-C Section 620 is similar to ISA 620 in both respects.

Determining the Extent of Supervision

See AS 1201.C2, as Adopted
    The Proposal supplemented, in proposed Appendix C of AS 1201, the 
factors set forth in AS 1201.06 for determining the necessary extent of 
supervision of engagement team members in circumstances involving the 
use of the work of an auditor-employed specialist.\91\
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    \91\ AS 1201.06 provides that, to determine the extent of 
supervision necessary for engagement team members, the engagement 
partner and other engagement team members performing supervisory 
activities should take into account, among other things: (1) The 
nature of the company, including its size and complexity; (2) the 
nature of the assigned work for each engagement team member; (3) the 
risks of material misstatement; and (4) the knowledge, skill, and 
ability of each engagement team member.
---------------------------------------------------------------------------

    No commenters opposed the proposed requirement for determining the 
extent of supervision. One commenter stated that the proposed 
requirement for determining the extent of supervision appeared scalable 
to the size and complexity of the audit engagement. The Board is 
adopting this requirement as proposed. The final requirements provide 
that the necessary extent of supervision depends on: (1) The 
significance of the specialist's work to the auditor's conclusion 
regarding the relevant assertion; (2) the risk of material misstatement 
of the relevant assertion; and (3) the knowledge, skill, and ability of 
the auditor-employed specialist relevant to the work to be performed by 
the specialist.

Comparison With Standards of Other Standard Setters

    Paragraph 8 of ISA 620 provides that, depending on the 
circumstances, the nature, timing and extent of the auditor's 
procedures will vary with respect to: (1) Evaluating the

[[Page 13462]]

competence, capabilities and objectivity of the auditor's expert; (2) 
obtaining an understanding of the field of expertise of the auditor's 
expert; (3) reaching an agreement with the auditor's expert; and (4) 
evaluating the adequacy of the auditor's expert's work. In determining 
the nature, timing and extent of those procedures, the auditor shall 
consider matters including:
    (a) The nature of the matter to which that expert's work relates;
    (b) The risks of material misstatement in the matter to which that 
expert's work relates;
    (c) The significance of that expert's work in the context of the 
audit;
    (d) The auditor's knowledge of and experience with previous work 
performed by that expert; and
    (e) Whether that expert is subject to the auditor's firm's quality 
control policies and procedures.
    AU-C Section 620 contains requirements that are similar to those in 
ISA 620.

Qualifications and Independence of Auditor-Employed Specialists

See AS 1015.06, as amended, and footnote 3A to AS 2101.06b, as amended
    PCAOB auditing standards require that personnel be assigned to 
engagement teams based on their knowledge, skill, and ability.\92\ This 
requirement applies equally to auditor-employed specialists and other 
engagement team members. In addition, auditor-employed specialists must 
be independent of the company.\93\ Accordingly, the requirements in 
PCAOB auditing standards for determining compliance with independence 
and ethics requirements apply to auditor-employed specialists.\94\ 
Rather than add specific requirements for evaluating the qualifications 
and independence of auditor-employed specialists, the Proposal would 
have included two paragraphs in Appendix C citing the applicable 
requirements in existing standards.\95\
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    \92\ See AS 2301.05a and AS 1015.06, as amended.
    \93\ PCAOB Rule 3520, Auditor Independence, requires a 
registered public accounting firm and its associated persons to be 
independent of the firm's ``audit client'' throughout the audit and 
professional engagement period, meaning that they must satisfy all 
independence criteria applicable to an engagement. In addition, 
under Rule 2-01 of Regulation S-X, 17 CFR 210.2-01, any professional 
employee of the ``accounting firm'' (as broadly defined in Rule 2-
01(f)(2) to include associated entities) who participates in an 
engagement of an audit client is a member of the ``audit engagement 
team,'' as that term is defined under Rule 2-01(f)(7)(i). The effect 
is that an accounting firm is not independent if it uses the work of 
a specialist employed by the accounting firm who does not meet the 
independence requirements of Rule 2-01.
    \94\ See AS 2101.06b.
    \95\ See proposed AS 1201.C3-.C4; see also AS 2301.05a, AS 
1015.06, and AS 2101.06b.
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    Most commenters on this topic advocated for greater acknowledgment 
of the auditor's ability to use information from the firm's system of 
quality control when assessing the knowledge, skill, ability, and 
independence of an auditor-employed specialist. Specifically, some of 
these commenters recommended the inclusion of references to QC 20, 
System of Quality Control for a CPA Firm's Accounting and Auditing 
Practice (``QC 20''), in these requirements. In the view of these 
commenters, QC 20 more fully encompasses both the considerations 
related to the appropriate assignment of personnel to an engagement and 
the requirements related to independence, integrity, and objectivity. 
One commenter suggested that the standard provide that a firm's system 
of quality control pursuant to QC 20 would be sufficient to satisfy the 
requirements relating to the qualifications and independence of 
auditor-employed specialists. Another commenter stated that the 
necessary guidance was contained in QC 20 and that the references in 
the Proposal to applicable requirements in existing standards were 
duplicative.
    The Board considered these comments in adopting the final 
amendments. The intent of the proposed paragraphs for assigning 
personnel based on their knowledge, skill, and ability, and for 
determining compliance with independence and ethics requirements, was 
to emphasize that auditors' responsibilities for assessing the 
qualifications and independence of the auditor-employed specialists are 
the same as for other engagement team members. To avoid any 
misunderstanding that a different process was expected for assigning 
auditor-employed specialists and determining their compliance with 
independence and ethics requirements, the proposed paragraphs do not 
appear in the final amendments. Also, two related amendments to PCAOB 
auditing standards are being adopted. First, AS 1015.06 has been 
amended to clarify that engagement team members, which includes 
auditor-employed specialists, should be assigned to tasks and 
supervised commensurate with their level of knowledge, skill, and 
ability, and that this requirement is not limited to the assignment and 
supervision of auditors. Second, in another conforming amendment, a 
footnote was added to AS 2101.06b to remind auditors of the obligations 
of registered firms and their associated persons under PCAOB Rule 3520.
    Under the final amendments, auditors will continue to have the 
ability to use information from, and processes in, the firm's quality 
control system when assessing the knowledge, skill, ability, and 
independence of auditor-employed specialists. The fact that a system of 
quality control may have a process for making assignments of 
specialists does not relieve the engagement partner (with the 
assistance of appropriate supervisory personnel on the engagement team) 
of his or her responsibility to determine whether the assigned 
specialist has the necessary qualifications and independence for the 
particular audit engagement in accordance with AS 1015.06, as amended, 
and AS 2101.06, as amended. The relevant facts and circumstances, 
including the nature, scope, and objectives of the specialist's work, 
should be considered when performing this assessment. For example, a 
valuation specialist may have expertise in valuing oil and gas 
reserves, but not in valuing coal reserves. In that case, failure to 
consider the specialist's expertise when assigning the specialist work 
on an audit engagement in an extractive industry could result in the 
inappropriate assignment of significant engagement responsibilities.

Comparison With Standards of Other Standard Setters

    Paragraph 9 of ISA 620 provides that the auditor shall evaluate 
whether the auditor's expert has the necessary competence, 
capabilities, and objectivity for the auditor's purposes.
    AU-C Section 620 contains requirements that are similar to those in 
ISA 620.

Informing the Specialist of the Work To Be Performed

See AS 1201.C3-.C5, as adopted
    The Proposal supplemented the requirements in PCAOB standards for 
informing the engagement team members of their responsibilities to 
address situations where auditor-employed specialists are performing 
work in an audit.\96\ Most commenters

[[Page 13463]]

who commented on the supplemental requirements generally supported the 
proposed approach, asserting that it would foster effective 
communication between the auditor and the auditor's specialist. Some 
commenters, however, asked for clarification of certain aspects of the 
proposed requirement to establish and document an understanding with 
the specialist of the work to be performed. After considering the 
comments received, the Board is adopting the requirements substantially 
as proposed.
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    \96\ AS 1201.05a sets forth requirements for the engagement 
partner and, as applicable, other engagement team members performing 
supervisory activities to inform engagement team members of their 
responsibilities. These matters include: (1) The objectives of the 
procedures that engagement team members are to perform; (2) the 
nature, timing, and extent of procedures they are to perform; and 
(3) matters that could affect the procedures to be performed or the 
evaluation of the results of those procedures, including relevant 
aspects of the company, its environment, and its internal control 
over financial reporting, and possible accounting and auditing 
issues.
---------------------------------------------------------------------------

    The final amendments include requirements for the engagement 
partner and, as applicable, other engagement team members performing 
supervisory activities to inform the auditor-employed specialist about 
the work to be performed. These requirements include establishing and 
documenting an understanding with the specialist regarding the 
responsibilities of the specialist, the nature of the specialist's 
work, the specialist's degree of responsibility for testing data and 
evaluating methods and significant assumptions, and the responsibility 
of the specialist to provide a report, or equivalent documentation.
    Some commenters requested clarification in the final amendments on 
the form of documentation of the auditor's understanding with the 
specialist. In addition, some commenters suggested removing the 
specific reference to the specialist's responsibility to provide a 
``report, or equivalent documentation'' and allowing for more 
flexibility when the specialist's results are communicated to the 
auditor. Some of these commenters asserted that the proposed 
requirement connoted the preparation of a formal, signed report, which 
could discourage effective two-way communication between the auditor 
and the specialist. Another commenter suggested that the Board consider 
whether the auditor's understanding with the specialist should also 
include matters the specialist should communicate to the auditor, and 
the nature, timing, and extent of those communications. One commenter 
also expressed concern that use of the term ``degree of 
responsibility'' could be seen as a means for auditors to abdicate 
responsibility for audit work to specialists.
    The final amendments do not include specific requirements for how 
to document the auditor's understanding with the auditor's specialist. 
Instead, the Board contemplates that the understanding with the 
specialist can be documented in a variety of ways, such as in planning 
memoranda, separate memoranda, or other related work papers. This 
approach should provide auditors with flexibility, while still 
requiring the documentation of the important aspects of the 
understanding reached by the auditor and the auditor's specialist. This 
approach also enables the specialist to communicate those matters 
specific to the work performed and does not limit the specialist's 
ability to communicate other items to the auditor.
    The final amendments also require the auditor to establish and 
document an understanding with the specialist regarding the degree of 
responsibility of the specialist for: (1) Testing data produced by the 
company, or evaluating the relevance and reliability of data from 
sources external to the company; (2) evaluating the significant 
assumptions used by the company or the company's specialist, or 
developing his or her own assumptions; and (3) evaluating the methods 
used by the company or the company's specialist, or using his or her 
own methods. The intent of this requirement is to enhance coordination 
of the work between the auditor and the auditor's specialist and 
facilitate supervision of the specialist by the engagement partner and 
others with supervisory responsibilities. For example, if the auditor's 
specialist assists the auditor in developing an independent expectation 
using data, assumptions, or a model provided by the auditor or 
auditor's specialist, the auditor would establish an understanding with 
the specialist regarding the specialist's responsibilities with respect 
to the data, assumptions, or model.\97\ Regardless of the specialist's 
degree of responsibility, the engagement partner and, as applicable, 
other engagement team members performing supervisory activities are 
responsible for evaluating the specialist's work and report, or 
equivalent documentation.\98\
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    \97\ AS 1201.C5, as adopted, provides that the auditor should 
comply with AS 2501.21-.26, as adopted, when an independent 
expectation is developed. For example, the auditor's 
responsibilities with respect to using data or assumptions obtained 
from a third party are presented in AS 2501.23, as adopted. See 
Estimates Release, supra note 20.
    \98\ See AS 1201.C6-.C7, as adopted.
---------------------------------------------------------------------------

    In addition, as proposed, the final amendments require establishing 
and documenting the specialist's responsibility to provide ``a report, 
or equivalent documentation'' to the auditor. This requirement should 
provide flexibility for auditors to obtain the necessary information 
about the specialist's procedures, findings, and conclusions through 
the specialist's report, other specialist-provided documentation, or a 
combination of the two. The requirement should also facilitate the 
auditor's compliance with other PCAOB auditing standards, such as those 
on engagement quality review and audit documentation.\99\
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    \99\ See AS 1220, Engagement Quality Review, and AS 1215, Audit 
Documentation.
---------------------------------------------------------------------------

    The final amendments require establishing and documenting the 
auditor's understanding with the specialist regarding the ``nature of 
the work that the specialist is to perform or assist in performing.'' 
As proposed, this requirement would have also encompassed the 
``specialist's approach to that work.'' Two commenters suggested that 
the Board clarify the difference between the two terms. The nature of 
the specialist's work would include, for example, testing data and 
evaluating the methods and significant assumptions used in developing 
an estimate when testing the company's process used to develop an 
accounting estimate or developing an independent expectation of an 
estimate. The specialist's approach to that work, in turn, might 
include the procedures the specialist performs to test management's 
process or develop an independent expectation, such as testing data and 
evaluating the methods and significant assumptions used in developing 
an estimate. Since the auditor's obligation to establish and document 
the specialist's degree of responsibility for performing similar 
procedures is addressed in other provisions of the final 
amendments,\100\ the phrase ``the specialist's approach to that work'' 
has been omitted to avoid potential confusion.
---------------------------------------------------------------------------

    \100\ See AS 1201.C3c, as adopted.
---------------------------------------------------------------------------

    As proposed, the final amendments also provide that, pursuant to AS 
1201.05a(3), the engagement partner and, as applicable, other 
engagement team members performing supervisory activities should inform 
the auditor-employed specialist about matters that could affect the 
specialist's work.\101\ This includes, as applicable, information about 
the company and its environment, the company's processes for developing 
the related accounting estimate, the company's use of specialists in 
developing the estimate, relevant requirements of the applicable 
financial reporting framework, possible accounting and auditing issues, 
and the need to apply professional skepticism. Commenters did not offer 
suggestions

[[Page 13464]]

on this provision, although one commenter stated that it concurred with 
the proposed requirement.
---------------------------------------------------------------------------

    \101\ See AS 1201.C4, as adopted.
---------------------------------------------------------------------------

    The final amendments also provide that the engagement partner and, 
as applicable, other engagement team members performing supervisory 
activities should implement measures to determine that there is a 
proper coordination of the work of the specialist with the work of 
other relevant engagement team members to achieve a proper evaluation 
of the evidence obtained in reaching a conclusion about the relevant 
assertion.\102\ One commenter requested clarification of the term 
``measures,'' as used in this context. The final requirement emphasizes 
that the auditor is responsible for complying with relevant auditing 
standards, including, when applicable, AS 2501, as adopted, and 
Appendix A of AS 1105, as adopted.\103\ This requirement is intended to 
prompt the auditor to coordinate with the specialist to make sure that 
the work is performed in accordance with the applicable standards, 
including the requirement to consider relevant audit evidence, 
regardless of whether it supports or contradicts the relevant financial 
statement assertion. For example, in auditing an accounting estimate 
under AS 2501, as adopted, measures taken by the auditor could include 
either performing, or supervising the auditor's specialist in 
performing, the required procedures with respect to testing and 
evaluating the data, and evaluating the methods and significant 
assumptions used in developing that estimate.\104\
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    \102\ See AS 1201.C5, as adopted.
    \103\ See AS 1201.C5, as adopted. In response to comments, this 
paragraph was revised in the final amendments to provide that, if an 
auditor's specialist is used to evaluate the work of a company's 
specialist, measures should be implemented to comply with Appendix A 
of AS 1105, as adopted, and, for accounting estimates, AS 2501.19, 
as adopted.
    \104\ See AS 2501, as adopted, and Estimates Release, supra note 
20.
---------------------------------------------------------------------------

Comparison With Standards of Other Standard Setters

    Paragraph 11 of ISA 620 provides that the auditor shall agree, in 
writing when appropriate, on the following matters with the auditor's 
expert:
    (a) The nature, scope and objectives of that expert's work;
    (b) The respective roles and responsibilities of the auditor and 
that expert;
    (c) The nature, timing, and extent of communication between the 
auditor and that expert, including the form of any report to be 
provided by that expert; and
    (d) The need for the auditor's expert to observe confidentiality 
requirements.
    AU-C Section 620 contains requirements that are similar to those in 
ISA 620.

Evaluating the Work of the Specialist

See AS 1201.C6-.C7, as Adopted
    The Proposal supplemented, in Appendix C, the requirements in AS 
1201.05c for reviewing the work of the engagement team in circumstances 
in which auditor-employed specialists are used.\105\ It provided that, 
if the specialist's findings or conclusions appear to contradict the 
relevant assertion or the specialist's work does not provide sufficient 
appropriate evidence, the engagement partner and, as applicable, other 
engagement team members performing supervisory activities should 
perform additional procedures, or request the specialist to perform 
additional procedures, as necessary to address the issue.
---------------------------------------------------------------------------

    \105\ AS 1201.05c provides that the engagement partner and, as 
applicable, other engagement team members performing supervisory 
activities should review the work of engagement team members to 
evaluate whether: (1) The work was performed and documented; (2) the 
objectives of the procedures were achieved; and (3) the results of 
the work support the conclusions reached.
---------------------------------------------------------------------------

    Commenters generally agreed with these requirements, noting that 
the requirements are appropriate and, in the view of some commenters, 
would improve audit quality. Two commenters asked for additional 
guidance on how the auditor should evaluate methods and assumptions 
used by an auditor-employed specialist. One commenter recommended 
providing additional guidance on the specific procedures to be 
performed by auditors to evaluate a specialist's work. After 
considering the comments, the Board is adopting the requirements 
substantially as proposed.
    The final amendments provide a principles-based framework for 
reviewing and evaluating the work of the specialist. Under the final 
amendments, the engagement partner and, as applicable, other engagement 
team members performing supervisory activities should review the 
specialist's report or equivalent documentation describing the work 
performed, the results of the work, and the findings or conclusions 
reached by the specialist, as provided for under AS 1201.C3d, as 
adopted.\106\
---------------------------------------------------------------------------

    \106\ See AS 1201.C6, as adopted.
---------------------------------------------------------------------------

    This approach links the scope of the auditor's review to the report 
or equivalent documentation that the specialist agreed to furnish to 
the auditor under AS 1201.C3, as adopted. The principles for the 
necessary extent of supervision, discussed earlier, also apply to 
evaluating the work of the auditor-employed specialist, including the 
report or equivalent documentation provided by the specialist. 
Accordingly, auditors should be familiar with this approach and how to 
apply this requirement in practice.
    The necessary extent of review and evaluation of the auditor-
employed specialist's work depends on (1) the significance of the 
specialist's work to the auditor's conclusion regarding the relevant 
assertion; (2) the risk of material misstatement of the relevant 
assertion; and (3) the knowledge, skill, and ability of the specialist. 
In performing the review, the auditor also should evaluate whether the 
specialist's work provides sufficient appropriate evidence, 
specifically whether:
     The specialist's work and report, or equivalent 
documentation, are in accordance with the auditor's understanding with 
the specialist; and
     The specialist's findings and conclusions are consistent 
with results of the work performed by the specialist, other evidence 
obtained by the auditor, and the auditor's understanding of the company 
and its environment.
    AS 1201.C7, as adopted, provides that, if the specialist's findings 
or conclusions appear to contradict the relevant assertion or the 
specialist's work does not provide sufficient appropriate evidence, the 
engagement partner and, as applicable, other engagement team members 
performing supervisory activities should perform additional procedures, 
or request the specialist to perform additional procedures, as 
necessary to address the issue. The final requirement also provides 
examples of situations in which additional procedures ordinarily would 
be necessary, including:
     The specialist's work was not performed in accordance with 
the auditor's instructions;
     The specialist's report, or equivalent documentation, 
contains restrictions, disclaimers, or limitations that affect the 
auditor's use of the report or work; \107\
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    \107\ The auditor's consideration of restrictions, disclaimers, 
or limitations in a report, or equivalent documentation, provided by 
an auditor-employed specialist is the same as when such language is 
contained in a report, or equivalent documentation, provided by an 
auditor-engaged specialist. See below for further discussion of the 
auditor's consideration of the effect of restrictions, disclaimers, 
or limitations on the report, or equivalent documentation, provided 
by the auditor-engaged specialist.
---------------------------------------------------------------------------

     The specialist's findings and conclusions are inconsistent 
with (1) the results of the work performed by the specialist, (2) other 
evidence obtained

[[Page 13465]]

by the auditor, or (3) the auditor's understanding of the company and 
its environment;
     The specialist lacks a reasonable basis for data or 
significant assumptions the specialist used; or
     The methods used by the specialist were not appropriate.
    These requirements are consistent with existing provisions in 
paragraphs .06 and .36 of AS 2810, Evaluating Audit Results, which 
provide that, if the auditor concludes that the evidence gathered is 
not adequate, he or she should modify his or her audit procedures or 
perform additional procedures as necessary (e.g., audit procedures may 
need to be modified or additional procedures may need to be performed 
as a result of any changes in the risk assessments). Similarly, if the 
evidence gathered by the specialist in testing or evaluating data, or 
evaluating significant assumptions is not adequate, the engagement 
partner and, as applicable, other engagement team members performing 
supervisory activities should perform additional procedures, or request 
the specialist to perform additional procedures, as necessary to 
address the issue.
    One commenter asserted that auditors may not have sufficient 
knowledge of the specialist's field of expertise to evaluate a 
specialist's work and effectively challenge methods, assumptions, and 
data, particularly in relation to highly complex technical areas. The 
final amendments recognize that the engagement partner and, as 
applicable, other engagement team members performing supervisory 
responsibilities may not have in-depth knowledge of the specialist's 
field. However, under existing PCAOB standards, the auditor is required 
to have sufficient knowledge of the subject matter to evaluate a 
specialist's work as it relates to the nature, timing, and extent of 
the auditor's work and the effects on the auditor's report.\108\ 
Furthermore, the evaluation of the specialist's work under the final 
amendments is based on matters that are within the capabilities of the 
auditor (e.g., whether the specialist followed instructions and whether 
the results of the work support the specialist's conclusions).
---------------------------------------------------------------------------

    \108\ See AS 2101.17.
---------------------------------------------------------------------------

    Another commenter asked for clarification of the term ``reasonable 
basis'' in the context of assessing whether the specialist lacks a 
reasonable basis for data or significant assumptions the specialist 
used. In that context, ``reasonable basis'' refers to whether the 
specialist's selection of data or significant assumptions was 
determined arbitrarily or instead based on consideration of relevant 
information available to the specialist.

Comparison With Standards of Other Standard Setters

    Paragraph 12 of ISA 620 provides that the auditor shall evaluate 
the adequacy of the auditor's expert's work for the auditor's purposes, 
including:
    (a) The relevance and reasonableness of that expert's findings or 
conclusions, and their consistency with other audit evidence;
    (b) If that expert's work involves use of significant assumptions 
and methods, the relevance and reasonableness of those assumptions and 
methods in the circumstances; and
    (c) If that expert's work involves the use of source data that is 
significant to that expert's work, the relevance, completeness, and 
accuracy of that source data.
    Paragraph 13 of ISA 620 provides that if the auditor determines 
that the work of the auditor's expert is not adequate for the auditor's 
purposes, the auditor shall:
    (a) Agree with that expert on the nature and extent of further work 
to be performed by that expert; or
    (b) Perform additional audit procedures appropriate to the 
circumstances.
    AU-C Section 620 contains requirements that are similar to those in 
ISA 620.
Amendments to Existing AS 1210 for Using the Work of an Auditor-Engaged 
Specialist
    This section discusses the final requirements in AS 1210, as 
amended, for audits in which the auditor uses an auditor-engaged 
specialist. In such circumstances, the objective of the auditor is to 
determine whether the work of the auditor-engaged specialist is 
suitable for the auditor's purposes and supports the auditor's 
conclusion regarding the relevant assertion.

Assessing the Knowledge, Skill, Ability, and Objectivity of the Engaged 
Specialist

    As described above, existing AS 1210 requires the auditor to 
evaluate the professional qualifications of a specialist and the 
relationship of a specialist to the company.
    Similar to the final amendments related to using a company's 
specialist, the final amendments carry forward the existing 
requirements with certain modifications described below.

Knowledge, Skill, and Ability

See AS 1210.03-.04, as Amended
    Requirements in existing AS 1210 related to the auditor's 
evaluation of a specialist's qualifications were described above with 
regard to a company's specialist. These requirements are the same for a 
company's specialist and an auditor-engaged specialist.
    The Proposal substantially carried forward the requirement in 
existing AS 1210. Unlike the existing standard, however, the Proposal 
expressly provided that the auditor would obtain an understanding of 
the professional qualifications of both the specialist and the entity 
that employs the specialist. The Board is adopting this requirement as 
proposed.
    Two commenters concurred with the proposed approach to assessing 
knowledge, skill, and ability of the auditor-engaged specialist. One 
commenter suggested allowing auditors to assess the specialist's 
knowledge, skill, and ability centrally as part of the firm's system of 
quality control. Another commenter asserted that the proposed 
requirement was not well-suited to assessing the knowledge, skill, and 
ability of the entity that employs the specialist.
    Under the final amendments, auditors will continue to be able to 
use information from, and processes in, the firm's quality control 
system when assessing the knowledge, skill, and ability of auditor-
engaged specialists. The fact that a system of quality control may have 
a firm-level process for screening engaged specialists does not relieve 
the engagement partner (with the assistance of appropriate supervisory 
personnel on the engagement team) of his or her responsibility to 
assess whether the engaged specialist has the necessary knowledge, 
skill, and ability for the particular audit engagement. The relevant 
facts and circumstances, including the nature, scope, and objectives of 
the specialist's work, should be considered when performing this 
assessment.
    The final requirement retains the concept in existing AS 1210 that 
a specialist may be an individual or an entity. Outreach to audit firms 
suggests that firms have policies and procedures for evaluating the 
qualifications of specialists, whether individuals or entities. 
Accordingly, auditors should be familiar with assessing the 
qualifications of entities that are specialists or employ specialists. 
Therefore, the final requirement is not expected to result in a 
significant change in practice.

[[Page 13466]]

    AS 1210, as amended, does not specify steps to perform or 
information sources to use in assessing the specialist's knowledge, 
skill, and ability. Potential sources of relevant information, if 
available, could include the following:
     Information contained within the audit firm related to the 
professional qualifications and reputation of the specialist and the 
entity that employs the specialist, if applicable, in the relevant 
field and experience with previous work of the specialist;
     Professional or industry associations and organizations, 
which may provide information on: (1) Qualification requirements, 
technical performance standards, and continuing professional education 
requirements that govern their members; (2) the specialist's education 
and experience, certification, and license to practice; and (3) 
recognition of, or disciplinary actions taken against the specialist;
     Information provided by the specialist about matters 
regarding the specialist's understanding of the financial reporting 
framework, experience in performing similar work, and the methods and 
assumptions used in the specialist's work the auditor plans to 
evaluate;
     The specialist's responses to questionnaires about the 
specialist's professional credentials; and
     Published books or papers written by the specialist.
    Requirements applicable to a specialist pursuant to legislation or 
regulation also could help inform the auditor's assessment of the 
specialist's knowledge, skill, and ability.
    The purpose of the assessment of the auditor-engaged specialist's 
knowledge, skill, and ability is two-fold: (1) To determine whether the 
specialist possesses a sufficient level of knowledge, skill, and 
ability to perform his or her assigned work; and (2) to help determine 
the necessary extent of the review and evaluation of the specialist's 
work. AS 1210.04, as amended, emphasizes the importance of engaging a 
sufficiently qualified auditor's specialist by expressly providing that 
the auditor should not use the work of an engaged specialist who does 
not have a sufficient level of knowledge, skill, and ability.
    The assessment of the specialist's knowledge, skill, and ability by 
the engagement partner and, as applicable, other engagement team 
members performing supervisory activities is also a factor when 
determining the necessary extent of the review and evaluation of the 
specialist's work.\109\ The auditor's evaluation of the work of a 
specialist may be more extensive if the specialist generally has 
sufficient knowledge, skill, and ability in the relevant field of 
expertise, but less experience in the particular area of specialty 
within the field. For example, a valuation specialist may possess 
sufficient knowledge, skill, and ability in business valuation, but may 
not be well-versed in the application of business valuation for 
financial reporting purposes.
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    \109\ See AS 1210.10, as amended.
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Objectivity

See AS 1210.05 and .11, as Amended
    Requirements in existing AS 1210 related to the auditor's 
evaluation of a specialist's objectivity are described above with 
regard to a company's specialist. Those requirements are the same for a 
company's specialist and an auditor-engaged specialist.
    The Proposal built on the requirements for assessing objectivity in 
the existing standard and provided that the engagement partner and, as 
applicable, other engagement team members performing supervisory 
activities would assess whether the specialist and the entity that 
employs the specialist have the necessary objectivity, which includes 
evaluating whether the specialist or the entity that employs the 
specialist has a relationship to the company (e.g., through employment, 
financial, ownership, or other business relationships, contractual 
rights, family relationships, or otherwise), or any other conflicts of 
interest relevant to the work to be performed.
    The proposed requirements differed from the existing requirements 
in two primary respects. First, they articulated the concept of 
objectivity for purposes of proposed AS 1210, as referring to the 
specialist's ability ``to exercise impartial judgment on all issues 
encompassed by the specialist's work related to the audit.'' Second, 
they expanded the list of matters that the auditor would consider in 
assessing objectivity to include financial and business relationships 
with the company and other conflicts of interest.
    Some commenters supported the proposed approach. Other commenters 
expressed concern that the proposed requirement implied that the 
assessment of whether the specialist had the necessary objectivity was 
a binary decision. These commenters expressed a preference for 
describing objectivity as an attribute that exists along a spectrum. 
Some of these commenters asserted that an auditor should not be 
precluded from using the work of a less objective specialist, as long 
as the auditor performed additional procedures in those circumstances.
    After considering the comments received, the requirement has been 
revised to allow auditors to assess the specialist's level of 
objectivity along a spectrum and use the work of a less objective 
specialist if the auditor performs additional procedures to evaluate 
the specialist's work. In revising this requirement, the Board took 
into account the need for auditors to assess the objectivity of 
auditor-engaged specialists, while allowing auditors, where 
appropriate, to engage specialists who have certain relationships with 
a company that may raise questions as to their level of objectivity.
    The final amendments also require the auditor to perform procedures 
that are commensurate with, among other things, an engaged specialist's 
degree of objectivity.\110\ Under the final amendments, if the 
specialist or the entity that employs the specialist has a relationship 
with the company that affects the specialist's objectivity, the auditor 
should (1) perform additional procedures to evaluate the data, 
significant assumptions, and methods that the specialist is responsible 
for testing, evaluating, or developing consistent with the 
understanding established with the specialist pursuant to AS 1210.06, 
as amended, or (2) engage another specialist. The necessary nature and 
extent of the additional procedures would depend on the degree of 
objectivity of the specialist. As the degree of objectivity increases, 
the evidence needed from additional procedures decreases.\111\ If the 
specialist has a low degree of objectivity,\112\ the auditor should 
apply the procedures for evaluating the work of a company's 
specialist.\113\ For example, if the specialist's employer has a 
significant ownership interest in the company, the specialist's ability 
to exercise objective and impartial judgment might be low and, 
therefore, the auditor should evaluate the data, significant 
assumptions, and methods used by the

[[Page 13467]]

specialist under the requirements in Appendix A of AS 1105, as amended.
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    \110\ See first note to AS 1210.05, as amended. See also AS 
1210.10, as amended, for a description of other factors affecting 
the necessary extent of the auditor's review.
    \111\ See AS 1210.11, as amended.
    \112\ The concept of a ``low degree of objectivity'' is used in 
paragraph .18 of AS 2201, An Audit of Internal Control Over 
Financial Reporting That Is Integrated with An Audit of Financial 
Statements, and, therefore, should be familiar to auditors.
    \113\ See AS 1210.11, as amended.
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    Some commenters on the Proposal suggested the Board should provide 
additional guidance to specify the steps to be performed by auditors to 
assess the objectivity of an auditor-engaged specialist, as well as 
what constitutes sufficient appropriate evidence to support this 
assessment. One commenter asserted that auditors would face challenges 
in assessing the objectivity of the entity that employs the specialist, 
as required under the Proposal, and suggested that auditors may be 
unable to obtain the policies, procedures, and systems, if any, of the 
entity employing the specialist. This commenter suggested either 
omitting the requirement to consider the objectivity of the 
specialist's employer or limiting the requirement to performing inquiry 
of the specialist.
    After considering these comments, the Board has eliminated the 
assessment of the objectivity of the entity that employs the specialist 
as a separate requirement under the final requirements. Instead, the 
auditor is required to evaluate relationships between the company and 
both the specialist and the specialist's employer to determine whether 
either has a relationship with the company that may adversely affect 
the specialist's objectivity.\114\ This is consistent with existing AS 
1210, under which a specialist may be either an individual or an 
entity. Additionally, outreach to specialist entities and audit firms 
suggests that audit firms have policies and procedures for evaluating 
relationships between a specialist entity that they engage and the 
company. Accordingly, the concept of assessing relationships between a 
company and an entity that employs specialists should be familiar to 
auditors.
---------------------------------------------------------------------------

    \114\ See AS 1210.05, as amended. For example, the specialist's 
employer might have an ownership or other financial interest with 
respect to the company, or other business relationships that might 
be relevant to the auditor's assessment of the specialist's ability 
to exercise objective and impartial judgment.
---------------------------------------------------------------------------

    As under the Proposal, the final amendments do not prescribe the 
procedures the auditor must perform to obtain information relevant to 
the auditor's assessment. In response to questions raised by 
commenters, the Board added a note to clarify that the evidence 
necessary to assess the specialist's objectivity depends on the 
significance of the specialist's work and the related risk of material 
misstatement.\115\ Under this principles-based approach, as the 
significance of the specialist's work and the risk of material 
misstatement increase, the persuasiveness of the evidence the auditor 
should obtain for this assessment also increases.
---------------------------------------------------------------------------

    \115\ See second note to AS 1210.05, as amended.
---------------------------------------------------------------------------

    In addition, the note includes non-exclusive examples of potential 
sources of information that could be relevant to the auditor's 
assessment of the relationship to the company of both the specialist 
and the specialist's employer.\116\ These examples include responses to 
questionnaires provided to the specialist regarding relationships 
between the specialist, or the specialist's employer, and the company. 
As with the auditor's assessment of a specialist's knowledge, skill, 
and ability, certain sources of information may provide more persuasive 
evidence than others. In situations where more persuasive evidence is 
required, it may be appropriate to perform procedures to obtain 
evidence from multiple sources.
---------------------------------------------------------------------------

    \116\ Id. These examples were based on examples set forth in the 
Proposal, but have been refined to better reflect their application 
in practice.
---------------------------------------------------------------------------

Comparison With Standards of Other Standard Setters

    Paragraph 9 of ISA 620 provides that in the case of an auditor's 
external expert, the evaluation of objectivity shall include inquiry 
regarding interests and relationships that may create a threat to that 
expert's objectivity.
    AU-C Section 620 contains requirements that are similar to those in 
ISA 620.

Informing the Specialist of the Work To Be Performed, Determining the 
Extent of Review, and Evaluating the Work of the Specialist

See AS 1210.06-.12, as Amended
    As is the case with respect to an auditor-employed specialist, the 
auditor uses an auditor-engaged specialist to assist the auditor in 
obtaining and evaluating audit evidence. Given the similar role of an 
auditor-employed and an auditor-engaged specialist in the audit, the 
final requirements for the auditor-engaged specialist are parallel to 
the requirements for the auditor-employed specialist when determining 
the extent of the auditor's review, informing the auditor-engaged 
specialist of the work to be performed, and evaluating the work of the 
auditor-engaged specialist. These final requirements are discussed in 
additional detail above.
    Some commenters on the Proposal commented on the impact of certain 
proposed changes solely with respect to auditor-engaged specialists. 
These comments are discussed below.
    One commenter on the Proposal expressed concern that the auditor 
may have limited access to proprietary models used by auditor-engaged 
specialists. This commenter recommended that the Board include 
statements made in the Proposal regarding the auditor's access to such 
models and the impact on the auditor's performance obligations in the 
final amendments. Similar to the Proposal, the final amendments do not 
require the auditor to have full access to a specialist's proprietary 
model or to reperform the work of the specialist, but instead require 
the auditor to evaluate the work of that specialist in accordance with 
the final standard. Under AS 1210.10, as amended, the necessary extent 
of the evaluation of the specialist's work, including a determination 
of the necessary access to a specialist's model, depends upon (1) the 
significance of the specialist's work to the auditor's conclusion 
regarding the relevant assertion; (2) the risk of material misstatement 
of the relevant assertion; and (3) the knowledge, skill, and ability of 
the specialist. For example, if the specialist used a proprietary model 
to develop an independent expectation, the auditor would need to obtain 
information from the specialist to assess whether the specialist's 
model was in conformity with the applicable financial reporting 
framework and to evaluate differences between the independent 
expectation and the company's recorded estimate.
    Another commenter recommended including a requirement to inform 
auditor-engaged specialists of the need to apply professional 
skepticism, similar to the requirement for auditor-employed specialists 
in proposed AS 1201.C6. A different commenter recommended that the 
requirements for informing the specialist of the work to be performed 
should include communicating the auditor's need to exercise 
professional skepticism to the auditor-engaged specialist, so that the 
specialist is aware that relevant information should be passed on to 
the auditor.
    The Board considered these comments and determined to adopt the 
requirement to inform the specialist of the work to be performed 
substantially as proposed. Due professional care in the performance of 
audit procedures requires the auditor to exercise professional 
skepticism, including a questioning mind and a critical assessment of 
audit evidence.\117\ The Board did not propose extending the auditing 
standard on due professional care to auditor-engaged specialists and,

[[Page 13468]]

therefore, no change has been made to AS 1210, as amended. While there 
is no requirement for auditors to make the engaged specialist aware of 
the auditor's responsibility to exercise professional skepticism, 
auditors nevertheless may decide to communicate the auditor's 
responsibility to the auditor-engaged specialist.
---------------------------------------------------------------------------

    \117\ See AS 1015.07.
---------------------------------------------------------------------------

    Some commenters asserted that the discussion of the auditor's 
assessment of disclaimers, limitations, and restrictions related to the 
report of a company's specialist was equally applicable to the report 
of the auditor-engaged specialist and recommended similar guidance be 
provided when using the report of an auditor-engaged specialist. Under 
the final amendments, the auditor's evaluation of the specialist's 
report or equivalent documentation includes considering the effect of 
any restrictions, limitations, or disclaimers in the specialist's 
report or equivalent documentation on both (1) the relevance and 
reliability of the audit evidence the specialist's work provides and 
(2) how the auditor can use the report of the specialist.\118\ For 
example, a specialist's report that states ``the values in this report 
are not an indication of the fair value of the underlying assets'' 
generally would not provide sufficient appropriate evidence related to 
fair value measurements. On the other hand, a specialist's report that 
indicates that the specialist's calculations were based on information 
supplied by management may still be appropriate for use by the auditor 
to support the relevant assertion, since the auditor would be required 
to test the data that was produced by the company and used in the 
specialist's calculations
---------------------------------------------------------------------------

    \118\ See note to AS 1210.12, as amended.
---------------------------------------------------------------------------

Comparison With Standards of Other Standard Setters

    The comparative requirements of the IAASB and the ASB were 
discussed above.
Other Considerations
    The Board proposed to rescind two auditing interpretations.\119\ 
The Board has taken commenters' views into account and determined not 
to rescind these interpretations at this time. The Board is 
incorporating key elements of each interpretation, however, in the 
final amendments. These matters are discussed below, along with certain 
requirements in existing AS 1210 that are not specifically addressed in 
the final amendments.
---------------------------------------------------------------------------

    \119\ Auditing interpretations provide guidance the auditor 
should be aware of and consider related to specific areas of the 
audit. See paragraph .11 of AS 1001, Responsibilities and Functions 
of the Independent Auditor.
---------------------------------------------------------------------------

Auditing Interpretation AI 11, Using the Work of a Specialist: Auditing 
Interpretations of AS 1210
    The Board proposed to rescind AI 11 in the Proposal. AI 11 provides 
guidance for auditing transactions involving transfers of financial 
assets, such as in securitizations that are accounted for under 
Statement of Financial Accounting Standards No. 140.\120\ The 
interpretation addresses an auditor's use of a legal opinion obtained 
from a company's legal counsel on matters that may involve the U.S. 
Bankruptcy Code, rules of the Federal Deposit Insurance Corporation 
(``FDIC''),\121\ and other federal, state, or foreign law to determine 
whether ``transferred assets have been isolated from the transferor--
put presumptively beyond the reach of the transferor and its creditors, 
even in bankruptcy or other receivership,'' which affects the 
accounting for the transaction under FAS No. 140. AI 11 also reiterates 
certain requirements in generally accepted accounting principles and 
PCAOB auditing standards. In addition, the interpretation includes 
illustrative examples of legal isolation letters based on FAS No. 140 
and certain provisions of the FDIC's original rule, both of which have 
been subsequently amended.
---------------------------------------------------------------------------

    \120\ See Financial Accounting Standards Board (``FASB''), 
Statement of Financial Accounting Standards (``FAS'') No. 140, 
Accounting for Transfers and Servicing of Financial Assets and 
Extinguishments of Liabilities. This standard was subsequently 
amended by FAS No. 166, Accounting for Transfers of Financial 
Assets--an amendment of FASB Statement No. 140, and codified into 
FASB Accounting Standards Codification (``ASC''), Topic 860, 
Transfers and Servicing.
    \121\ Subsequent to the Board's adoption of AI 11, the FDIC rule 
regarding the treatment of financial assets transferred by an 
institution in connection with a securitization or participation was 
amended in 2010.
---------------------------------------------------------------------------

    A few commenters supported the proposed rescission. A number of 
other commenters, however, expressed concern about the proposed 
rescission of AI 11, stating that it continues to provide useful 
guidance to auditors regarding the necessary audit evidence to support 
management's assertion that a transfer of financial assets has met the 
isolation criterion of ASC 860-10-40, Transfers and Servicing. One 
commenter asserted that companies would struggle to anchor their 
accounting conclusions to guidance on the existing auditing standards 
if AI 11 was rescinded.
    After considering comments and the continued use of the 
interpretation in practice, the Board determined not to rescind AI 11 
at this time. The final amendments have been revised to include 
conforming changes to AI 11 to remove outdated references to existing 
AS 1210, which has been replaced and retitled.
    The amended standards for using the work of a company's specialist 
also incorporate certain principles from AI 11. As discussed in AI 11, 
legal opinions are sometimes necessary evidence to support an auditor's 
conclusion about the proper accounting for transfers of financial 
assets. Accordingly, the final amendments clarify that Appendix A of AS 
1105, as adopted, applies in situations when an auditor uses the work 
of a company's attorney as audit evidence in other matters relating to 
legal expertise, such as when a legal interpretation of a contractual 
provision or a legal opinion regarding isolation of transferred 
financial assets is necessary to determine appropriate accounting or 
disclosure under the applicable financial reporting framework.\122\ The 
provision emphasizes the importance of legal opinions as audit evidence 
in certain contexts and clarifies the requirements the auditor should 
be applying in such circumstances.
---------------------------------------------------------------------------

    \122\ See second note to AS 1105.A1, as adopted.
---------------------------------------------------------------------------

Auditing Interpretation AI 28, Evidential Matter Relating to Income Tax 
Accruals: Auditing Interpretations
    The Board also proposed to rescind AI 28 in the Proposal. AI 28 
provides guidance about matters related to auditing the income tax 
accounts in a company's financial statements. Topics covered by the 
interpretation include restrictions on access to the company's books 
and records related to its income tax calculation, documentation of 
evidence obtained in auditing the income tax accounts, and use of tax 
opinions from company legal counsel and tax advisors. The 
interpretation also reiterates certain requirements from PCAOB auditing 
standards.
    Most commenters did not express a view regarding the proposed 
rescission of AI 28. A few commenters supported the proposed 
rescission. Two commenters asserted that AI 28 provides useful guidance 
to auditors regarding tax specialists and tax working papers and should 
be retained. The Board has considered these comments and determined not 
to rescind AI 28 at this time.
    The Board recognizes that written advice or opinions of a company's 
tax advisor or tax legal counsel on material tax matters are sometimes 
necessary evidence to support the auditor's

[[Page 13469]]

conclusions on income tax accounts. Accordingly, the Board revised the 
final amendments to acknowledge such situations and to clarify that, if 
an auditor plans to use an opinion of legal counsel or the advice of a 
tax advisor on specific tax issues as audit evidence, it is not 
appropriate for the auditor to rely solely on that opinion or advice 
with respect to those tax issues.\123\ Instead, the auditor needs to 
evaluate the analysis underlying the tax opinion or tax advice to 
determine whether it provides relevant and reliable evidence, taking 
into account the requirements of the applicable financial reporting 
framework.
---------------------------------------------------------------------------

    \123\ See footnote 1 to AS 1105.A1, as adopted; note to AS 
2505.08, as amended.
---------------------------------------------------------------------------

Certain Requirements of Existing AS 1210--Discussion of Remaining 
Requirements Not Specifically Addressed in the Final Amendments
    Decision to use a specialist. Existing AS 1210 states that an 
auditor may encounter complex or subjective matters that are 
potentially material to the financial statements. It further provides 
that such matters, examples of which are provided, may require special 
skill or knowledge and in the auditor's judgment require using the work 
of a specialist to obtain appropriate evidential matter.\124\ The final 
amendments do not retain this language, as this issue is already 
addressed in AS 2101. Specifically, AS 2101.16 requires the auditor to 
determine whether specialized skill or knowledge is needed to perform 
appropriate risk assessments, plan or perform audit procedures, or 
evaluate audit results.
---------------------------------------------------------------------------

    \124\ See existing AS 1210.06.
---------------------------------------------------------------------------

    Reporting requirements. Existing AS 1210 prohibits auditors from 
making reference to the work or findings of a specialist in the 
auditor's report, unless such reference will facilitate an 
understanding of the reason for an explanatory paragraph, a departure 
from an unqualified opinion, or a critical audit matter (``CAM''). A 
CAM is defined as any matter arising from the audit of the financial 
statements that was communicated or required to be communicated to the 
audit committee and that relates to accounts or disclosures that were 
material to the financial statements and involved especially 
challenging, subjective, or complex auditor judgment.\125\ Depending on 
the circumstances, the description of such CAMs might include a 
discussion of the work or findings of a specialist.
---------------------------------------------------------------------------

    \125\ See AS 3101.11-.17.
---------------------------------------------------------------------------

    No commenters objected to omitting the prohibition in existing AS 
1210 from the proposed amendments. For the reasons discussed above, the 
Board did not make changes to the final amendments to incorporate these 
extant requirements.
Other Aspects of the Final Amendments
    The Board adopted additional amendments to conform its standards to 
the final requirements in AS 1105, AS 1201, and AS 1210, as amended. 
Those conforming amendments to AS 1015, AS 2301, AS 2310, The 
Confirmation Process, AS 2401, Consideration of Fraud in a Financial 
Statement Audit, AS 2610, Initial Audits--Communications Between 
Predecessor and Successor Auditors, AT 601, Compliance Attestation, and 
AT 701, Management's Discussion and Analysis, do not change the meaning 
of existing requirements.
Effective Date
    The Board determined that the final amendments take effect, subject 
to approval by the SEC, for audits of financial statements for fiscal 
years ending on or after December 15, 2020.
    The Board sought comment on the amount of time auditors would need 
before any amendments would become effective, if adopted by the Board 
and approved by the SEC. A number of commenters supported an effective 
date of two years after SEC approval of final amendments, asserting 
that this would allow firms sufficient time to develop tools, update 
methodologies, and provide training on the new requirements. A few 
commenters also emphasized the importance of having the same effective 
date for any new standards on using the work of specialists and 
auditing accounting estimates.
    While recognizing other implementation efforts, the effective date 
determined by the Board is designed to provide auditors with a 
reasonable period of time to implement the final amendments, without 
unduly delaying the intended benefits resulting from these improvements 
to PCAOB standards. The effective date is also aligned with the 
effective date of the related standards and amendments being adopted in 
the Estimates Release.

D. Economic Considerations and Application to Audits of Emerging Growth 
Companies

    The Board is mindful of the economic impacts of its standard 
setting. This economic analysis describes the baseline for evaluating 
the economic impacts of the final amendments, analyzes the need for the 
final amendments, and discusses potential economic impacts of the final 
amendments, including the potential benefits, costs, and unintended 
consequences. The analysis also discusses alternatives considered.
    In the Proposal, the Board had requested input from commenters on 
their views pertinent to the economic considerations, including the 
potential benefits and costs, discussed in the Proposal. One commenter 
stated that it believed the Proposal can be effectively implemented 
with minimal cost. Several commenters expressed concern, however, that 
the cost of the Proposal would be relatively greater for smaller audit 
firms and certain smaller companies. Some commenters also asserted that 
the Proposal would adversely affect the ability of smaller firms to 
compete in the audit services market. A number of commenters suggested 
that the incremental cost of certain aspects of the Proposal would 
outweigh any increase in audit quality. Finally, some commenters 
expressed concern that the Proposal could result in a shortage of 
qualified specialists due to, for example, a potential increase in the 
demand for specialists by some audit firms under the proposed 
requirements.\126\
---------------------------------------------------------------------------

    \126\ See below for a discussion of revisions to the proposed 
requirements in the final amendments to address this concern.
---------------------------------------------------------------------------

    The Board has considered all comments received, and has made 
certain changes to the final amendments to reflect those comments, 
including changes that mitigate some of the concerns expressed above 
with respect to the Proposal. The Board has also sought to develop an 
economic analysis that evaluates the potential benefits and costs of 
the final amendments, as well as facilitates comparisons to alternative 
Board actions. There are limited data and research findings available 
to estimate quantitatively the economic impacts of discrete changes to 
auditing standards in this area, and furthermore, no additional data 
was identified by commenters that would allow the Board to generally 
quantify the expected economic impacts (including expected incremental 
costs related to the Proposal) on audit firms or companies.\127\ 
Accordingly, the Board's discussion of the economic impact is 
qualitative in nature.
---------------------------------------------------------------------------

    \127\ One commenter provided anecdotal data on certain aspects 
of the Proposal that was limited to the commenter's experience in 
one specialized area. The data provided by this commenter, 
therefore, could not be used to quantify expected economic impacts 
that would generally apply to the use of the work of specialists.

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[[Page 13470]]

Baseline
    Section C above discusses existing PCAOB requirements for using the 
work of specialists and existing practice in the application of those 
requirements. This section addresses from an economic perspective: (1) 
The prevalence and significance of audits involving specialists; (2) 
the existing audit requirements that apply to the use of the work of 
specialists; and (3) the quality of audits that involve specialists, 
based on observations from regulatory oversight and academic 
literature.

Prevalence and Significance of Audits Involving Specialists

Evidence From PCAOB Inspections Data
    The Proposal observed that the PCAOB staff's analysis of 
inspections data for audits of issuers suggests that larger audit firms 
extensively use the work of specialists, in particular auditor-employed 
specialists, while smaller audit firms generally have a lower 
percentage of audit engagements in which they use the work of a 
company's specialist or an auditor's specialist.
    The conclusion regarding larger audit firms was based on a PCAOB 
staff analysis of the 274 issuer audits \128\ by U.S. audit firms 
affiliated with global networks \129\ that were selected for inspection 
in 2015. This analysis found that auditors used the work of at least 
one auditor-employed specialist in about 85 percent of those audits. 
For the 85 percent of those audits that involved the use of auditor-
employed specialists, an average of four to five individual specialists 
performed some work on each audit. In addition, on each of those 
audits, specialists performed work in one to two fields of expertise on 
average.\130\ The results indicate that such audits typically had more 
than one specialist performing work in the same area of expertise.
---------------------------------------------------------------------------

    \128\ This analysis was performed on engagement-level data 
obtained through PCAOB inspections. The audits inspected by the 
PCAOB are most often selected based on risk rather than selected 
randomly, and these numbers may not represent the use of the work of 
specialists across a broader population of companies. On average, 
the engagements selected for inspection are more likely to be 
complex (and thus more likely to involve the use of the work of a 
specialist) than the overall population of audit engagements.
    \129\ These firms consist of those U.S. audit firms that are 
registered with the PCAOB and affiliated with one of the six largest 
global networks, based on information on network affiliations 
reported by U.S. audit firms on Form 2 in 2017 and identified on the 
``Global Networks'' overview page, available on the Board's website.
    \130\ The data used in this analysis did not indicate how 
frequently the auditor used the work of an auditor-engaged 
specialist.
---------------------------------------------------------------------------

    The Proposal further noted that PCAOB inspections data for issuer 
audits suggested that, in contrast to larger audit firms, smaller U.S. 
audit firms generally have fewer audit engagements in which they use 
the work of a company's specialist or an auditor's specialist. 
Specifically, the PCAOB staff analyzed data from the 361 audits 
performed by U.S. audit firms not affiliated with one of the global 
networks that were selected for inspection by the PCAOB in 2015. Of 
those 361 issuer audits, the PCAOB staff identified: (1) 36 Audits 
(i.e., about 10% of the analyzed audit engagements) in which the 
auditor used the work of a company's specialist but did not use the 
work of an auditor's specialist; (2) 24 audits (i.e., about 7% of the 
analyzed audit engagements) in which the auditor used the work of an 
auditor's specialist but did not use the work of a company's 
specialist; (3) 30 audits (i.e., about 8% of the analyzed audit 
engagements) in which the auditor used the work of a company's 
specialist and an auditor's specialist; and (4) 271 audits (i.e., about 
75% of the analyzed audit engagements) in which the auditor neither 
used the work of a company's specialist nor used an auditor's 
specialist.
    A PCAOB staff analysis of the 700 issuer audits by audit firms that 
were selected for inspection in 2017 is broadly consistent with the 
conclusions in the Proposal regarding the prevalence and significance 
of audits involving specialists.\131\ The results of this analysis are 
summarized in the table below:
---------------------------------------------------------------------------

    \131\ The discussion in note 128 that applies to the 2015 
analysis--regarding the selection of inspected audit engagements and 
how such engagements likely compare to the overall population of 
audit engagements--likewise applies to this 2017 analysis. Unlike 
the 2015 analysis, the engagement-level data selected for the 
analysis of PCAOB inspections performed in 2017 included data on 
issuer audit engagements conducted by non-U.S. as well as U.S. audit 
firms. In addition, this engagement-level data was based on specific 
focus areas, such as recurring audit deficiencies and audit areas 
that may involve significant management or auditor judgment, for 
issuer audit engagements selected for inspection. For a more 
detailed discussion of PCAOB inspection focus areas, see PCAOB, 
Staff Inspection Brief: Information about 2017 Inspections, Vol. 
2017/3 (Aug. 2017).

  Figure 5--Audits Performed by U.S. and Non-U.S. Audit Firms That Were Selected for Inspection by the PCAOB in
                               2017, Categorized by Use of the Work of Specialists
----------------------------------------------------------------------------------------------------------------
                                                                                                  % (number) of
                                            % (number) of     % (number) of     % (number) of       audits by
                                          audits by larger      audits by     audits by larger   smaller  audit
                                             audit firms     smaller  audit      audit firms      firms  (non-
                                               (U.S.)         firms  (U.S.)      (non-U.S.)           U.S.)
----------------------------------------------------------------------------------------------------------------
(1) auditor used the work of a company's           8% (26)          10% (28)            8% (7)            6% (1)
 specialist but did not use the work of
 an auditor's specialist................
(2) auditor used the work of an                   20% (66)            2% (6)          34% (29)            0% (0)
 auditor's specialist but did not use
 the work of a company's specialist.....
(3) auditor used the work of both a              41% (136)           6% (17)          29% (25)            0% (0)
 company's specialist and an auditor's
 specialist.............................
(4) auditor neither used the work of a           31% (102)         81% (216)          29% (25)          94% (16)
 company's specialist nor used an
 auditor's specialist \132\.............
                                         -----------------------------------------------------------------------
    Total \133\.........................        100% (330)        100% (267)         100% (86)         100% (17)
----------------------------------------------------------------------------------------------------------------
Source: PCAOB.

    As indicated by Figure 5, auditors used the work of an auditor's 
specialist in 61% and 63% of the analyzed audit engagements (the sum of 
categories (2) and (3) above) by larger audit firms--U.S. and non-U.S. 
firms, respectively--selected for inspection in 2017. Auditors used the 
work of a company's specialist without also using the work of an 
auditor's specialist (category (1) above) in only 8% of the analyzed 
audit engagements of larger audit firms--both

[[Page 13471]]

U.S. and non-U.S. firms, respectively--selected for inspection in 2017. 
These results are also consistent with the anecdotal evidence discussed 
in section C (i.e., that larger audit firms generally require their 
engagement teams to evaluate the work of a company's specialist, 
including the specialist's methods and significant assumptions, and 
often employ specialists to assist their audit personnel in evaluating 
that work).
---------------------------------------------------------------------------

    \132\ The audit engagements not included in the preceding three 
categories were included in the fourth category.
    \133\ The total for the values shown in categories (1) through 
(4) may not add to 100% due to rounding.
---------------------------------------------------------------------------

    The results for smaller audit firms in Figure 5 are also consistent 
with the analysis in the Proposal and suggest that the work of an 
auditor's specialist or a company's specialist is used in relatively 
few audits. Specifically, in 81% and 94% of the audits by smaller audit 
firms--U.S. and non-U.S. firms, respectively--the auditor neither used 
the work of a company's specialist nor used an auditor's specialist 
(category (4) above), possibly because those audits did not involve 
circumstances that warranted the use of specialists by companies or 
their auditors. Consistent with the analysis of the issuer audits 
selected for inspection in 2015, the results for smaller audit firms in 
Figure 5 further suggest that, when smaller audit firms use the work of 
a company's specialist, they often use that work without concurrently 
using the work of an auditor's specialist. In 62% of the audits by 
smaller U.S. firms that involved the use of the work of a company's 
specialist, the audit firm did not concurrently use the work of an 
auditor's specialist.\134\ An auditor's specialist also was not 
concurrently involved in the only audit by a smaller non-U.S. firm that 
involved the use of the work of a company's specialist (category (1) 
above).
---------------------------------------------------------------------------

    \134\ Specifically, out of the 45 audit engagements of smaller 
U.S. firms that involved the use of the work of a company's 
specialists (the sum of categories (1) and (3) in Figure 5), 28 
engagements did not concurrently involve the use of the work of an 
auditor's specialist (category (1) in Figure 5).
---------------------------------------------------------------------------

Evidence From the Academic Literature
    Consistent with the results of the PCAOB staff analysis, the 
academic literature suggests that, when a company uses a company's 
specialist, some larger audit firms also tend to use the work of an 
auditor's specialist, at least in the context of audits involving 
challenging fair value measurements.\135\ Furthermore, the academic 
literature also suggests that the use of valuation specialists is 
prevalent for at least some audits. One recent study of audits by the 
four largest firms that involved challenging fair value measurements 
found that 86% of audit teams used an auditor's specialist, including 
employed and engaged specialists.\136\ In addition, 60% of the 
companies in this study used a company's specialist, including employed 
and engaged specialists.\137\ The audits that were included in this 
study may not be representative of all audit engagements, because they 
were selected in order to study engagements that involved material, 
highly challenging fair value measurements. However, the results 
suggest that the use of an auditor's specialist is at least prevalent 
among audits performed by the four largest U.S. firms where a company's 
specialist is used to assist in the development of highly challenging 
and material fair value measurements, which may also be audit areas 
with a high risk of material misstatement and thus a need for greater 
audit attention.\138\
---------------------------------------------------------------------------

    \135\ See, e.g., Nathan H. Cannon and Jean C. Bedard, Auditing 
Challenging Fair Value Measurements: Evidence From the Field, 92 (4) 
The Accounting Review 81 (2017) (study using an experiential 
questionnaire involving audit partners and managers of Big 4 firms 
in audits involving challenging fair value measurements).
    \136\ See Cannon and Bedard, Auditing Challenging Fair Value 
Measurements: Evidence From the Field 90. In another study of how 
auditors use valuation specialists, auditors from seven large U.S. 
audit firms who were interviewed stated that, on average, 61% of 
their engagements in the prior year involved a valuation specialist, 
including auditor-employed and/or auditor-engaged specialists. See 
Emily E. Griffith, Auditors, Specialists, and Professional 
Jurisdiction in Audits of Fair Values 13 (July 2016) (working paper, 
available in Social Science Research Network (``SSRN'')).
    \137\ See Cannon and Bedard, Auditing Challenging Fair Value 
Measurements: Evidence From the Field 90.
    \138\ Another recent qualitative study conducted through 
interviewing audit partners, managers, and seniors also observed 
that auditors in the six large audit firms in Canada consider 
factors such as the ``client's regulatory environment and other 
general risk factors,'' ``lack of subject matter expertise within 
the audit team,'' and ``complexity of the engagement'' when 
determining whether to use a specialist. See J. Efrim Boritz, 
Natalia Kochetova-Kozloski, Linda A. Robinson, and Christopher Wong, 
Auditors' and Specialists' Views About the Use of Specialists During 
an Audit 28, 35 (Mar. 2017) (working paper, available in SSRN).
---------------------------------------------------------------------------

    Furthermore, the academic literature also corroborates the 
characterizations discussed in section C regarding the current practice 
of audit firms when using specialists. Academic studies suggest that, 
at least among the audits that were studied where specialists were 
used, larger firms were more likely to use the work of auditor-employed 
specialists than auditor-engaged specialists in their engagements,\139\ 
while even among the larger firms there are differences in the extent 
of their use of the work of auditor-engaged specialists.\140\
---------------------------------------------------------------------------

    \139\ See, e.g., Steven M. Glover, Mark H. Taylor, and Yi-Jing 
Wu, Current Practices and Challenges in Auditing Fair Value 
Measurements and Complex Estimates: Implications for Auditing 
Standards and the Academy, 36 (1) Auditing: A Journal of Practice & 
Theory 63, 75 (2017) (``[R]esults indicate that approximately two-
thirds (one-third) of our participants reported that they use in-
house (third-party) valuation specialists to support the audit work 
performed for financial FVMs [i.e., fair value measurements]. 
Moreover, approximately 87 percent (13 percent) of the audit 
partners indicated that they use in-house (third-party) valuation 
specialists to support the audit work for nonfinancial FVMs.''); see 
also Emily E. Griffith, Jacqueline S. Hammersley, and Kathryn 
Kadous, Audits of Complex Estimates as Verification of Management 
Numbers: How Institutional Pressures Shape Practice, 32 Contemporary 
Accounting Research 833, 836 (2015) (``[A]uditors [from the U.S. 
audit firms affiliated with the six largest global networks] 
typically enlist audit-firm specialists in auditing estimates 
because they do not have valuation expertise. . .'').
    \140\ See Griffith, Auditors, Specialists, and Professional 
Jurisdiction in Audits of Fair Values 58. In this study, all 
participating auditors from Big 4 audit firms indicated that they 
used internal valuation specialists (i.e., auditor-employed 
valuation specialists) and did not use any external valuation 
specialists (i.e., auditor-engaged valuation specialists). In 
contrast, only 40% of the auditors from the three other audit firms 
that participated in the study indicated that they exclusively used 
internal valuation specialists.
---------------------------------------------------------------------------

    A possible explanation for the tendency of larger firms to use the 
work of auditor-employed specialists (instead of auditor-engaged 
specialists) is that larger firms, due to the greater number of their 
audit engagements or their existing non-auditing practices, have 
sufficient demand for the services of specialists to warrant hiring 
specialists who work for them full-time. In contrast, smaller firms may 
not have many audit engagements where the auditor requires the use of 
an auditor's specialist, so that engaging an auditor's specialist only 
as needed may be economically more advantageous. In addition, the 
tendency of smaller firms to look to the work of a company's specialist 
without using the work of an auditor's specialist may reflect the fact 
that existing AS 1210 enables the auditor to use the work of a 
company's specialist in a wide range of situations, without imposing 
obligations on the auditor that might call for the retention of an 
auditor's specialist.\141\
---------------------------------------------------------------------------

    \141\ Similarly, the final amendments enable the auditor to use 
the work of a company's specialist in a wide range of situations, 
without necessarily obligating the auditor to retain an auditor's 
specialist.
---------------------------------------------------------------------------

PCAOB Auditing Standards Regarding Use of the Work of Specialists

    As discussed in more detail in section C, under existing standards, 
the auditor's primary responsibilities with respect to a company's 
specialist are set forth in existing AS 1210. That standard also 
imposes the same responsibilities on auditors with respect to an 
auditor-engaged specialist, even though an auditor-engaged specialist 
has a

[[Page 13472]]

fundamentally different role than a company's specialist. While the 
auditor's specialist performs work to assist the auditor in obtaining 
and evaluating audit evidence, the company's specialist performs work 
that is used by the company in preparing its financial statements and 
that the auditor may use as audit evidence.
    The professional relationships between an auditor and a company's 
specialist, and between an auditor and an auditor's specialist, differ, 
among other things, in terms of who is employing or engaging the 
specialist (i.e., the company in the case of a company's specialist and 
the auditor in the case of an auditor's specialist). Therefore, the 
level of control and oversight an auditor is able to exercise over the 
specialist also differs. Given these differences, which expose a 
company's specialist and an auditor-engaged specialist to different 
incentives and biases (e.g., pressure to conform to management 
bias),\142\ requirements would ideally differentiate between the two 
types of specialists, but existing requirements do not do so.
---------------------------------------------------------------------------

    \142\ For a discussion of pressures facing a company's 
specialist, see Divya Anantharaman, The Role of Specialists in 
Financial Reporting: Evidence from Pension Accounting, 22 Review of 
Accounting Studies 1261, 1299-300 (2017) (concluding that ``client 
pressure and opinion shopping'' affect the work product of actuaries 
used by company management, which ``suggests potentially greater 
effects for other specialists not subject to the same levels of 
oversight (e.g., experts in valuing complex financial instruments 
and other untraded assets)'' and that ``economically important 
clients of their actuaries use more aggressive (obligation-reducing) 
discount rates [than] less important clients of the same actuary'').
---------------------------------------------------------------------------

    In contrast, existing PCAOB requirements for using the work of an 
auditor-employed specialist, who is subject to supervision under AS 
1201, differ from the requirements that apply to using the work of an 
auditor-engaged specialist. Auditor-employed and auditor-engaged 
specialists may differ in their economic dependency on the auditor and, 
by extension, could face different incentives to acquiesce to certain 
auditor decisions, such as a decision by the auditor to downplay or 
suppress unfavorable information in order to accommodate a conclusion 
sought by the auditor.\143\ While anecdotal evidence from the academic 
literature related to a company's specialists suggests that employed 
specialists may face stronger incentives to do so than engaged 
specialists,\144\ it is difficult to generalize as to whether auditor-
employed specialists have a greater economic dependency on auditors 
than auditor-engaged specialists.\145\ Any potential bias by auditor-
employed and auditor-engaged specialists arising from economic 
dependency on the auditor may be mitigated by the responsibility 
imposed directly on the engagement partner under AS 1201 for 
supervision of the work of engagement team members and compliance with 
PCAOB standards, including those regarding using the work of 
specialists. In addition, AS 1220 requires the engagement quality 
reviewer to ``evaluate the significant judgments made by the engagement 
team and the related conclusions reached in forming the overall 
conclusion on the engagement and in preparing the engagement report.'' 
Such significant judgments may include areas where auditors used the 
work of an auditor-employed or auditor-engaged specialist.
---------------------------------------------------------------------------

    \143\ See, e.g., Griffith, Auditors, Specialists, and 
Professional Jurisdiction in Audits of Fair Values 32 (``[A]udit 
teams delete extraneous information in specialists' memos when that 
information contradicts what the audit team has documented in other 
audit work papers . . .'') and 33 (``Auditors and specialists 
described several defensive behaviors by auditors that restrict 
specialists' access to information . . . Restricting specialists' 
access to information can influence how specialists do their work, 
what work they do, and what conclusions they reach.'').
    \144\ See, e.g., J. Richard Dietrich, Mary S. Harris, and Karl 
A. Muller III, The Reliability of Investment Property Fair Value 
Estimates, 30 Journal of Accounting and Economics 125, 155 (2001) 
(``[O]ur investigation reveals that the reliability of fair value 
estimates varies according to the relation between the appraiser and 
the [company] (internal versus external appraiser) . . . We find 
evidence that appraisals conducted by external appraisers result in 
relatively more reliable fair value accounting estimates (i.e., 
lower conservative bias, greater accuracy and lower managerial 
manipulation).'').
    \145\ The extent of economic dependency of an auditor-employed 
specialist on the auditor will depend, for example, on how much of 
the specialist's work and the specialist's compensation is related 
to audits (as opposed to non-audit services), which may vary for 
different auditor-employed specialists. Similarly, the extent of 
economic dependency of an auditor-engaged specialist on the auditor 
will depend on how much of the specialist's overall work or income 
is connected to the particular audit firm, which may vary for 
different auditor-engaged specialists.
---------------------------------------------------------------------------

    Furthermore, auditor-employed and auditor-engaged specialists serve 
similar roles in helping auditors obtain and evaluate audit evidence. 
Given their similar roles, it seems appropriate that the auditor would 
follow similar requirements when using both types of specialists, 
though existing requirements differ for the two types of specialists. A 
notable difference in the relationship of the auditor with auditor-
employed and auditor-engaged specialists, however, relates to the 
integration of auditor-employed specialists (as compared with auditor-
engaged specialists) in an audit firm's or network's quality control 
systems, which allows the auditor greater visibility into any 
relationships that might affect the auditor-employed specialist's 
independence, as well as greater visibility into the auditor-employed 
specialist's knowledge, skill, and ability. The final requirements with 
respect to evaluating the objectivity, as well as knowledge, skill, and 
ability, of an auditor-engaged specialist, therefore, sought to reflect 
that difference by providing the auditor with specific requirements to 
assess whether the auditor-engaged specialist has both the necessary 
objectivity to exercise impartial judgment on all issues encompassed by 
the specialist's work related to the audit and the level of knowledge, 
skill, and ability to perform the specialist's work related to the 
audit.
    As discussed in more detail below, given the similar role of an 
auditor-employed and an auditor-engaged specialist in the audit, the 
auditor's procedures for reaching an understanding with the specialist 
and evaluating the work to be performed by the specialist should be 
similar. However, due to the differences in the auditor's ability to 
assess the specialist's independence, as well as the specialist's 
knowledge, skill, and ability, the Board is adopting separate, but 
parallel, requirements for using the work of an auditor-employed 
specialist and an auditor-engaged specialist. It is expected that there 
would be few differences in the procedures undertaken by the auditor 
when using an auditor's specialist, whether employed or engaged, with 
such differences limited to the auditor's assessment of the knowledge, 
skill, ability, and objectivity of an auditor-engaged specialist (where 
the auditor may not be able to leverage an audit firm's or network's 
quality control system to perform these assessments).
Quality of Audits That Involve Specialists
    As discussed in section C, PCAOB oversight of audit engagements in 
which auditors used the work of a company's or an auditor's specialist 
and SEC enforcement actions have identified instances of noncompliance 
with PCAOB standards, e.g., situations where auditors did not 
appropriately evaluate the work of specialists. For issuer audit 
engagements, PCAOB staff have more recently observed a decline in the 
number of instances in which auditors at some audit firms did not 
perform sufficient procedures related to the work of an auditor's 
specialist. There are some preliminary indications that some, but not 
all, firms with observed deficiencies have undertaken remedial actions 
in response to such findings,

[[Page 13473]]

which may have contributed, at least in part, to improvements in audit 
quality related to the auditor's use of an auditor's specialist.
    Relatively few empirical academic studies have explicitly examined 
the relationship between the use of specialists and perceptions of 
audit quality by investors and auditors.\146\ This may be because it is 
difficult, especially for investors, to assess the effect of using 
specialists on audit quality independently from the effects of other 
relevant factors, such as the quality of the company's financial 
reporting or internal controls.\147\ However, available studies have 
investigated the relationship between the quality of financial 
statement estimates, which often are provided with the assistance of a 
company's specialist, and the usefulness of such estimates to 
investors. These studies find that less reliable estimates tend to be 
less useful to investors.\148\ Other studies suggest that some 
estimates are also more likely to be discounted by investors.\149\ 
Because investors' perceptions of the credibility of financial 
statements are influenced by their perceptions of audit quality, the 
auditor's appropriate use of the work of specialists should increase 
the credibility of the accounting estimates included in the financial 
statements.
---------------------------------------------------------------------------

    \146\ See, e.g., Brant E. Christensen, Steven M. Glover, Thomas 
C. Omer, Marjorie K Shelley, Understanding Audit Quality: Insights 
from Audit Professionals and Investors, 33 Contemporary Accounting 
Research 1648, 1667 (2016) (``Audit professionals [that were 
surveyed as part of the study] associate the use of both external 
experts and internal specialists with higher audit quality.''). 
Relatedly, one recent academic study examined the relationship 
between the use of forensic accountants (described by the authors as 
``specialists'') and the value of their involvement as perceived by 
the auditor. While forensic accountants are not specialists within 
the scope of this standard, the authors of the study argued that the 
findings ``likely translate into understanding other specialist 
domains.'' The authors suggested that the involvement of forensic 
accountants is accompanied by the ``incremental discovery of . . . 
material misstatements,'' and further stated that ``our results 
indicate both auditors and forensic specialists recognize the value 
and additional comfort that come from forensic specialist 
involvement on audits.'' See J. Gregory Jenkins, Eric M. Negangard, 
and Mitchell J. Oler, Getting Comfortable on Audits: Understanding 
Firms' Usage of Forensic Specialists, Contemporary Accounting 
Research, in-press 4 (2017).
    \147\ While not directly assessing the relationship between the 
use of specialists and perceptions of audit quality, academic 
literature has investigated factors that influence an auditor's 
approach to auditing accounting estimates, including the decision 
whether to use the work of specialists. See, e.g., Jennifer R. Joe, 
Scott D. Vandervelde, Yi-Jing Wu, Use of High Quantification 
Evidence in Fair Value Audits: Do Auditors Stay in their Comfort 
Zone?, 92 (5) The Accounting Review 89 (2017); Emily E. Griffith, 
When Do Auditors Use Specialists' Work to Improve Problem 
Representations of and Judgments about Complex Estimates?, 93 (4) 
The Accounting Review 177 (2018).
    \148\ See, e.g., Scott A. Richardson, Richard G. Sloan, Mark T. 
Soliman, and Irem Tuna, Accrual Reliability, Earnings Persistence 
and Stock Prices, 39 Journal of Accounting and Economics 437, 437-
438 (2005) (finding that ``less reliable accruals lead to lower 
earnings persistence . . . leading to significant security 
mispricing'').
    \149\ See, e.g., Chang Joon Song, Wayne B. Thomas, and Han Yi, 
Value Relevance of FAS No. 157 Fair Value Hierarchy Information and 
the Impact of Corporate Governance Mechanisms, 85 The Accounting 
Review 1375 (2010). Furthermore, the academic literature notes that 
auditing estimates with extreme uncertainty can pose significant 
challenges for auditors. See, e.g., Brant E. Christensen, Steven M. 
Glover, and David A. Wood, Extreme Estimation Uncertainty in Fair 
Value Estimates: Implications for Audit Assurance, 31 (1) Auditing: 
A Journal of Practice & Theory 127 (2012).
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Need for the Rulemaking
    From an economic perspective, the primary cause for market failure 
\150\ that motivates the need for the final amendments is the moral 
hazard \151\ affecting the auditor's decisions on how to implement 
audit procedures related to the use of the work of a specialist, which 
increases the risk of lower audit quality from the investor's 
perspective.
---------------------------------------------------------------------------

    \150\ For a discussion of the concept of market failure, see, 
e.g., Francis M. Bator, The Anatomy of Market Failure, 72 The 
Quarterly Journal of Economics 351 (1958); and Steven G. Medema, The 
Hesitant Hand: Mill, Sidgwick, and the Evolution of the Theory of 
Market Failure, 39 History of Political Economy 331 (2007).
    \151\ The moral hazard problem is also referred to as a hidden 
action, or agency problem, in economics literature. The term ``moral 
hazard'' refers to a situation in which an agent could take actions 
(such as not working hard enough) that are difficult to monitor by 
the principal and would benefit the agent at the expense of the 
principal. To mitigate moral hazard problems, the agent's actions 
need to be better aligned with the interests of the principal. 
Monitoring is one mechanism to mitigate these problems. See, e.g., 
Bengt Holmstr[ouml]m, Moral Hazard and Observability, 10 The Bell 
Journal of Economics 74 (1979).
---------------------------------------------------------------------------

    As described in the Proposal, the moral hazard problem related to 
the use of the work of a specialist generally manifests in the auditor 
not performing appropriate procedures, even though such procedures 
would improve audit quality by increasing the auditor's attention, 
because the auditor may not perceive sufficient economic benefit 
(compared to the corresponding costs \152\ and efforts) from such 
actions. Specifically, when auditors use the work of a company's 
specialist, moral hazard may take the form of the auditor failing to 
evaluate data, significant assumptions, and methods used by the 
specialist to an extent that would be commensurate with the risk of 
material misstatement inherent in the specialist's work. Moral hazard 
in the context of auditors using the work of a company's specialist 
might also take the form of the auditor failing to appropriately assess 
relationships between the company's specialist and the company.\153\ In 
addition, when auditors use the work of an auditor's specialist, moral 
hazard may, for example, take the form of not performing procedures, or 
performing insufficient procedures, to communicate and reach an 
understanding with the specialist regarding the specialist's 
responsibilities and the objectives of the specialist's work, or 
insufficiently evaluating that work.\154\
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    \152\ For a discussion of the effect of cost pressures on audit 
quality, compare James L. Bierstaker and Arnold Wright, The Effects 
of Fee Pressure and Partner Pressure on Audit Planning Decisions, 18 
Advances in Accounting 25, 40 (2001) (finding, as the result of 
their experiment, that ``auditors significantly reduced budgeted 
hours . . . and planned tests . . . in response to fee pressure'') 
with Bernard Pierce and Breda Sweeney, Cost-Quality Conflict in 
Audit Firms: An Empirical Investigation, 13 European Accounting 
Review 415 (2004) (finding, in relation to the Irish market, that 
``dysfunctional behaviours'' are related to time pressure and 
performance evaluation).
    \153\ See Anantharaman, The Role of Specialists in Financial 
Reporting: Evidence from Pension Accounting, at 1265 (describing 
empirical evidence that suggests that auditors ``have difficulty in 
screening out relationships'' that might impair the ``objectivity'' 
of company specialists).
    \154\ Alternatively, it is conceivable that, in some situations, 
moral hazard may take the form of the auditor either influencing the 
findings or conclusions that specialists reach or modifying the 
specialist's work after the fact to support the conclusions sought 
by the auditor. See supra note 143.
---------------------------------------------------------------------------

    In such contexts, moral hazard is made possible by the information 
asymmetry \155\ that exists due to the lack of transparency about the 
nature of the auditor's work (i.e., between the auditor on the one 
hand, and investors on the other hand). Investors typically do not know 
whether an auditor used the work of a specialist and, if so, how the 
work of the specialist was used. Because of this information asymmetry, 
the auditor may face little to no scrutiny from investors or others 
(e.g., audit committees) regarding his or her audit procedures when 
using the work of specialists,\156\ and may perceive limited

[[Page 13474]]

economic benefits (e.g., gains in revenue, gains in professional 
reputation, or a reduction in potential liability) in incurring costs 
to perform additional audit work. Hence, the moral hazard problem 
between the auditor and investors may have a detrimental impact on 
audit quality.\157\
---------------------------------------------------------------------------

    \155\ Economists often describe ``information asymmetry'' as an 
imbalance, where one party has more or better information than 
another party. For a discussion of the concept of information 
asymmetry, see, e.g., George A. Akerlof, The Market for ``Lemons'': 
Quality Uncertainty and the Market Mechanism, 84 The Quarterly 
Journal of Economics 488 (1970).
    \156\ This is true for other aspects of the audit engagement as 
well and hence the audit can be thought of providing investors with 
a credence service. Credence services are difficult for users of the 
service (such as investors in the context of company audit services) 
to value because their benefits are difficult to observe and 
measure. See Monika Causholli and W. Robert Knechel, An Examination 
of the Credence Attributes of an Audit, 26 Accounting Horizons 631 
(2012). See also Alice Belcher, Audit Quality and the Market for 
Audits: An Analysis of Recent UK Regulatory Policies, 18 Bond Law 
Review 1, 5 (2006) (An ``audit is a credence service in that its 
quality may never be discovered by the company, the shareholders or 
other users of the financial statements. It may only come into 
question if a `clean' audit report is followed by the collapse of 
the company.'').
    \157\ Additionally, such situations may occur because the 
auditor made an error in judgment assessing the audit risk involved 
when using the work of an auditor's specialist or a company's 
specialist. In situations in which ``objectives and the actions 
needed to achieve them are complex and multifaceted, it is 
inevitable that different people . . . will . . . interpret . . . 
them in different ways . . .'' See John Hendry, The Principal's 
Other Problems: Honest Incompetence and the Specification of 
Objectives, 27 Academy of Management Review 98, 107-108 (2002). When 
people are choosing their actions in such situations, Hendry argues 
that the predicted actions (and hence resulting problems) are more 
or less the same, whether one assumes that they are unselfish yet 
``prone to mak[ing] mistakes,'' or instead are self-interested and 
opportunistic yet unlikely to make mistakes. Id. at 100.
---------------------------------------------------------------------------

    Because market forces (e.g., pressure and demands from investors) 
may not be effective in making the auditor more responsive to investor 
interests with respect to the use of the work of specialists,\158\ from 
an economic perspective, the situation absent standards would be 
characterized as a form of market failure. While existing standards 
regarding the use of the work of a company's specialist and an auditor-
engaged specialist are intended to address and mitigate potential 
auditor moral hazard, they could be aligned more closely with the risk 
assessment standards, which could enhance audit quality. In addition, 
while auditor-employed specialists are supervised under a risk-based 
approach, specifying requirements for applying that approach when using 
an auditor-engaged specialist could promote an improved, more uniform 
approach to supervision. Additionally, if the work of an auditor's 
specialist is not properly overseen or evaluated (or the work of a 
company's specialist is not properly evaluated), there may be a 
heightened risk that the auditor's work will not be sufficient to 
detect a material misstatement in significant accounts and disclosures.
---------------------------------------------------------------------------

    \158\ The degree of responsiveness of the auditor to investor 
interests, such as increasing audit effort in some circumstances 
when using the work of specialists, may also be related to, among 
other things, the auditor's ability to pass on cost increases to 
companies (and, ultimately, to investors) in the form of higher 
audit fees. See infra note 175 for a further discussion of cost 
pass-through.
---------------------------------------------------------------------------

    Furthermore, the auditor does not engage or employ a company's 
specialist and does not supervise the work of a company's specialist. 
This makes the auditor's use of the work of a company's specialist 
different from the auditor's use of an auditor's specialist in several 
important ways. First, because of the different relationships the 
auditor has with a company's specialist and with an auditor's 
specialist, the auditor's assessment of the qualifications and 
relationships of a company's specialist requires greater effort by the 
auditor compared to the auditor's equivalent procedures with respect to 
an auditor's specialist. Second, the auditor's consideration of data, 
significant assumptions, and methods used by the company's specialist 
may also be more challenging (for example, due to the specialist's use 
of proprietary data), compared to equivalent procedures performed by 
the auditor when using a specialist with whom the auditor has an 
employment or contractual relationship. Third, an auditor is generally 
more likely to be familiar with an auditor's specialist than with a 
company's specialist (e.g., with the professional qualifications, 
reputation, and work), which reduces the costs associated with the 
ongoing monitoring of the specialist's work. Given these differences, 
the standards would ideally differentiate between the two types of 
specialists, but existing AS 1210 currently does not do so. 
Accordingly, the potential for moral hazard relating to the auditor's 
use of the work of a company's specialist is a particular focus of the 
requirements in the final amendments to AS 1105.
    The need to enhance existing standards is further heightened by the 
fact that it may be particularly challenging for the auditor to 
evaluate the work of either an auditor's specialist or a company's 
specialist or to supervise an auditor's specialist. The work of a 
company's specialist or an auditor's specialist often involves 
professional judgment, the nature of which the auditor may not fully 
appreciate when evaluating the work of the specialist. In particular, 
the specialist's work is highly technical in nature and often is not 
entirely transparent to the auditor, who may not have complete access 
to the specialist's work \159\ or the same level of knowledge and skill 
in the specialist's field.\160\ Thus, due to the potential that an 
auditor would incur relatively higher cost to supervise an auditor's 
specialist or to evaluate the work of a company's or an auditor's 
specialist, the auditor may have incentives to forego procedures 
related to the use of the work of specialists that could be beneficial 
to investors.
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    \159\ For example, as further discussed in section C, some 
commenters on the Proposal expressed concern that the auditor may 
have limited access to proprietary information used by a company's 
specialist or an auditor-engaged specialist (as compared with 
information used by an auditor-employed specialist). The final 
amendments do not require the auditor to obtain such proprietary 
information, but instead to obtain sufficient information to assess 
whether the model is in conformity with the applicable financial 
reporting framework.
    \160\ See, e.g., Griffith, Auditors, Specialists, and 
Professional Jurisdiction in Audits of Fair Values 23 (``[Results] 
show[ ] that many auditors review specialists' work for general 
understanding and sufficiency of the work performed, rather than 
reviewing in detail as they would in other areas of the audit. They 
approach the review this way because they cannot fully understand 
specialists' work.'').
---------------------------------------------------------------------------

    The potential negative impact on audit quality of the auditor's 
incentives to forgo procedures is compounded by the possibility that an 
auditor's specialist may perceive little benefit (compared to the 
corresponding costs and efforts) in fully carrying out their 
responsibilities, including the objectives of the work to be 
performed.\161\ Alternatively, the specialist may in some instances 
believe that he or she faces few negative consequences (such as an 
increase in potential liability) when performing low quality work or, 
as one commenter on the Proposal asserted, an auditor's specialist may 
not set forth conclusions anticipated to be rejected by the auditor. 
However, any such concerns are at least partially alleviated to the 
extent specialists are subject to codes of conduct, standards, and 
disciplinary processes of their own profession or could perceive a risk 
of reputational damage.\162\
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    \161\ To the extent that an auditor's specialist has a stronger 
relationship with the auditor (e.g., repeated business interactions 
between the specialist and the auditor), the potential for moral 
hazard arising in the context of the auditor using such an auditor's 
specialist could be higher. However, a stronger relationship between 
the auditor and the auditor's specialist may also result in the 
specialist's work being more commensurate with the risk of material 
misstatement associated with the financial statement assertion and, 
therefore, improve audit quality.
    \162\ See, e.g., Letter from American Academy of Actuaries (Aug. 
29, 2017), at 1-2, available on the Board's website in Docket 044 
(stating that the Academy's members ``are subject to a code of 
professional conduct, standards of qualification and practice, and a 
disciplinary process'' and that ``our profession has a specific 
standard that defines appropriate practice for actuaries during the 
course of an audit'').
---------------------------------------------------------------------------

    The Proposal stated that enhanced performance standards regarding 
the use of the work of specialists might improve audit quality and 
benefit investors. One commenter asserted that the Proposal had not 
articulated a pervasive problem that would be solved by a change in 
auditing standards. This commenter further stated that it was not 
persuaded

[[Page 13475]]

that a change in the audit framework for the auditor's use of 
specialists was necessary, based on its view that a significant amount 
of audit work is currently being performed. The Board believes, 
however, that the changes in the final amendments described in section 
C are needed (and preferable to other policy-making approaches) \163\ 
because market forces alone cannot mitigate the moral hazard problem 
described above.
---------------------------------------------------------------------------

    \163\ See below for a discussion of why the Board believes that 
standard setting is preferable to other policy-making approaches.
---------------------------------------------------------------------------

    Strengthening the requirements for evaluating the work of a 
company's specialist, as well as applying a risk-based supervisory 
approach when using the work of both auditor-employed and auditor-
engaged specialists, will prompt auditors to plan and perform audit 
procedures commensurate with the risk of material misstatement inherent 
in the specialist's work, and thereby mitigate the moral hazard 
problem. The final amendments direct more audit attention and effort, 
when using the work of specialists, to areas where the specialist's 
work is more significant to the auditor's conclusion on a financial 
statement assertion and the risk of material misstatement is higher.
    Specifically, as discussed in section C, the final amendments 
mitigate the moral hazard problem by linking the auditor's 
responsibilities for determining the necessary evidence when evaluating 
the work of the company's specialist, including the data, significant 
assumptions, and methods used by the specialist, to four factors: The 
risk of material misstatement of the relevant assertion; the 
significance of the specialist's work to the auditor's conclusion 
regarding that assertion; the level of knowledge, skill, and ability of 
the specialist; and the ability of the company to significantly affect 
the specialist's judgments about the work performed, conclusions, or 
findings.
    Further, the final amendments mitigate the moral hazard problem in 
the context of the use of the work of an auditor's specialists by 
clarifying the auditor's supervisory responsibilities over auditor-
employed specialists and establishing parallel requirements when 
auditors use the work of auditor-engaged specialists, as discussed in 
section C. In addition, the necessary extent of supervision under the 
final amendments depends on factors similar to those that govern the 
necessary auditor effort in evaluating the work of a company's 
specialist.

Economic Impacts

    The magnitude of the benefits and costs of the final amendments 
will be affected by the nature of and risks involved in the work 
performed by specialists, because more complex work and work in areas 
of greater risk will likely require greater audit effort, holding all 
else constant. In addition, benefits and costs are likely to be 
affected by the degree to which auditors have already adopted audit 
practices and methodologies that are similar to those that the final 
amendments will require.\164\
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    \164\ Additionally, the new standard and related amendments in 
the Estimates Release, supra note 20, may affect the future 
prevalence and significance of the use of the work of specialists 
and, therefore, have an impact on the benefits and costs of the 
final amendments discussed in this section.
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    The remainder of this subsection discusses the potential benefits, 
costs, and unintended consequences that may result from the final 
amendments the Board is adopting.
Benefits
    The requirements in the final amendments are expected to benefit 
investors and auditors by directing auditors to devote more attention 
to the work of specialists and enhancing the coordination between 
auditors and their specialists. This should mitigate the problem of 
auditor moral hazard discussed in the preceding section and contribute 
to improved audit quality. The final amendments are intended to 
accomplish this, and increase the likelihood that auditors will detect 
material misstatements, through requirements that take into account 
current auditing practices by some larger audit firms and more strongly 
align auditors' interests with the interests of investors when auditors 
use the work of specialists. At the same time, by fostering improved 
audit quality, the final amendments should increase investors' 
perception of the credibility of a company's financial statements, and 
help address uncertainty about audit quality and the potential risks 
associated with the use of the work of company specialists, auditor-
employed specialists, and auditor-engaged specialists.
    The Board believes that investors will benefit from the final 
amendments because the application of the requirements should result in 
more consistently rigorous practices among auditors when using the work 
of a company's specialist in their audits, as well as a more consistent 
approach to the supervision of auditor-employed and auditor-engaged 
specialists. The current divergence in practices related to the 
auditor's use of the work of specialists, combined with a lack of 
information about such divergence, could mean that investors are unable 
to distinguish the quality of each audit separately, which in turn 
could lead investors to discount the quality of all audits. Conversely, 
greater consistency in such practices--such as would be promoted by the 
final amendments--could mitigate those concerns by both enhancing the 
quality of less rigorous audits and correcting the inappropriate 
discounting of more rigorous audits. From an investor's perspective, 
and as one commenter concurred, the increase in audit quality that 
should result from the final amendments should contribute to investor 
protection. Specifically, an increase in audit quality may increase the 
quality of the information provided in a company's financial statements 
and decrease the cost of capital for that company,\165\ especially if 
less information is available about the company because it has a 
shorter financial reporting history.\166\
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    \165\ See, e.g., Richard A. Lambert, Christian Leuz, and Robert 
E. Verrecchia, Accounting Information, Disclosure, and the Cost of 
Capital, 45 Journal of Accounting Research 385, 386-7 (2007) 
(``[A]ccounting information influences a [company's] cost of capital 
. . . where higher quality accounting information . . . affects the 
market participants' assessments of the distribution of future cash 
flows''); see also Randolph P. Beatty, Auditor Reputation and the 
Pricing of Initial Public Offerings, 64 The Accounting Review 693, 
696 (1989) (``Since auditing firms that have invested more in 
reputation capital have greater incentives to reduce application 
errors, the information disclosed in the accounting reports audited 
by these firms will be more precise, ceteris paribus. This reduction 
in measurement error will allow uninformed investors to estimate 
more precisely the distribution of firm value.'').
    \166\ See, e.g., Jeffrey A. Pittman and Steve Fortin, Auditor 
Choice and the Cost of Debt Capital for Newly Public Firms, 37 
Journal of Accounting and Economics 113, 114 (2004) (``[E]ngaging 
[an audit firm with] a brand name reputation for supplying higher-
quality audit that enhances the credibility of financial statements, 
enables young [companies] to reduce their borrowing costs . . . 
[O]ur research suggests that the economic value of auditor 
reputation declines with age as [companies] shift toward exploiting 
their own reputations to reduce information asymmetry.'').
---------------------------------------------------------------------------

    From a broader capital markets perspective, an increase in the 
information quality of a company's financial statements because of 
improved audit quality can increase the efficiency of capital 
allocation decisions. In other words, an increase in the information 
quality of companies' financial statements can reduce the non-
diversifiable risk to investors and generally should result in 
investment decisions by investors that more accurately reflect the 
financial position

[[Page 13476]]

and operating results of each company.\167\
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    \167\ See, e.g., Lambert et al., Accounting Information, 
Disclosure, and the Cost of Capital 388 (finding that information 
quality directly influences a company's cost of capital and that 
improvements in information quality by individual companies 
unambiguously affect their non-diversifiable risks.); Ahsan Habib, 
Information Risk and the Cost of Capital: Review of the Empirical 
Literature, 25 Journal of Accounting Literature 127, 128 (2006) (``A 
commitment to increased level [and quality] of disclosure reduces 
the possibility of information asymmetries and hence should lead to 
a lower cost of capital effect. . . . In addition, high quality 
auditing . . . could provide credible information in the market 
regarding the future prospect of the [company] and hence could 
reduce the cost of capital in general, and cost of equity capital in 
particular.'' (footnote omitted)).
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    In addition to the general benefits to investors and the capital 
markets described above, the final amendments should result in specific 
benefits to auditors. In particular, the final amendments should lead 
to improvements in the ability of auditors to supervise auditor-
employed and auditor-engaged specialists and evaluate their work, to 
the extent that auditors devote more attention to the work of auditor-
employed and auditor-engaged specialists and enhance the coordination 
with those specialists. The final amendments with regard to the use of 
the work of a company's specialist should also lead to improvements in 
the auditor's understanding of the data, significant assumptions, and 
methods used by the company's specialist. As auditors are better able 
to identify and detect potential risks of material misstatement, this 
may also spur companies and their specialists over time to improve the 
quality of financial reporting and their work.
    The final amendments may also contribute to the aggregate benefits 
of the auditing standards (i.e., by enhancing auditors' understanding 
of, and compliance with, other PCAOB auditing standards), in addition 
to the other improvements in audit quality described above. For 
example, the final amendments to evaluate the work of a company's 
specialist should result in some auditors developing a better 
understanding of the company's accounting estimates in significant 
financial statement accounts and disclosures. In turn, this may also 
result in improved communications with audit committees.\168\
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    \168\ See paragraphs .12c and .13c of AS 1301, Communications 
with Audit Committees, for the auditor's communication requirements 
related to the company's critical accounting estimates.
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    The magnitude of the benefits discussed in this section resulting 
from improved audit quality will likely vary to the extent that current 
practices are aligned with the final amendments. Based on observations 
from the Board's oversight activities, most firms would need to enhance 
their methodologies, but to varying degrees. In general, both the 
greatest changes and the greatest benefits are likely to occur with 
auditors that need to enhance their methodologies the most.
Costs
    The Board recognizes that the benefits of the final amendments will 
come at additional costs to auditors and the companies they audit. As 
with any changes to existing requirements, it is anticipated that there 
will be one-time costs for auditors associated with updating audit 
methodologies and tools, preparing new training materials, and 
conducting training.\169\ The final amendments could also give rise to 
recurring costs in the form of additional time and effort spent on any 
individual audit engagement by specialists and engagement team members.
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    \169\ The PCAOB has observed that larger firms are likely to 
update their methodologies using internal resources, whereas smaller 
firms are more likely to purchase updated methodologies from 
external vendors.
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    The most significant impact of the final amendments on costs for 
auditors is expected to result from the requirements to evaluate the 
work of a company's specialist. This area of potential impact was also 
noted by some commenters on the proposed requirements for testing and 
evaluating the work of a company's specialist.
    Compared with the existing requirements,\170\ the auditor will be 
required under the final amendments to evaluate the significant 
assumptions used by the company's specialist whenever the specialist's 
work is used, rather than only in certain circumstances,\171\ as well 
as the methods used by the specialist. In practice, these requirements 
may result in auditors performing more work or using an auditor's 
specialist to assist them in evaluating the work of a company's 
specialist. This may lead to significant changes in practice for some 
firms, particularly smaller firms that currently do not employ 
specialists and follow methodologies solely based on existing AS 1210, 
even though the final amendments do not require the auditor to use the 
work of an auditor's specialist.
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    \170\ See existing AS 1210.12.
    \171\ In circumstances when an auditor is auditing fair value 
measurements and disclosures in accordance with AS 2502, footnote 2 
of that standard provides that management's assumptions include 
assumptions developed by a specialist engaged or employed by 
management. Therefore, the auditor is currently required to evaluate 
the reasonableness of significant assumptions developed by the 
company's specialist when auditing a fair value measurements and 
disclosures.
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    Compared to the Proposal, however, the final amendments clarify the 
auditor's responsibility when evaluating the work of the company's 
specialist and, therefore, should further limit any incremental cost to 
circumstances where increases in audit quality can be reasonably 
expected. For example, as detailed in section C, the final amendments 
reflect changes to the Proposal relating to the auditor's evaluation of 
the data, significant assumptions, and methods used by the company's 
specialist. These revisions clarify that the focus of the auditor's 
evaluation does not require reperforming the specialist's work. 
Instead, the auditor's responsibility is to evaluate whether the 
specialist's work provides sufficient appropriate evidence to support a 
conclusion regarding whether the corresponding accounts or disclosures 
in the financial statements are in conformity with the applicable 
financial reporting framework.
    In addition, some of the expected cost increases for auditors due 
to the final amendments are likely to be offset by the implementation 
of more risk-based audit approaches in practice (e.g., more targeted 
procedures when using the work of specialists). More risk-based audit 
approaches reduce the risk to the auditor of failing to detect material 
misstatement and thus could lead to a reduction in costs resulting from 
potential liability or reputational loss faced by auditors.
    The final amendments' impact on costs for auditors could also vary 
based on the size and complexity of an audit engagement. Holding all 
else constant, anticipated costs generally would be higher for larger, 
more complex audits than for smaller, less complex audits.\172\ As 
discussed above, a smaller portion of audits performed by smaller audit 
firms tend to involve use of the work of specialists, compared with 
audits performed by larger audit firms. Accordingly, it is reasonable 
to infer that relatively fewer audits of smaller firms will be impacted 
by the final amendments than audits of larger firms.
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    \172\ See Letter from American Academy of Actuaries (July 31, 
2015), at 18, available on the Board's website in Docket 044 
(stating that ``smaller audit firms also tend to have clients that 
require fewer special needs'' and thus implying that audit 
engagements of smaller audit firms tend to be less complex than 
audit engagements of larger audit firms).
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    The impact of the final amendments would also likely vary, however, 
depending on the extent to which elements of the final amendments have 
already been incorporated in an audit

[[Page 13477]]

firm's methodologies or applied in practice by individual engagement 
teams. For auditors that have already implemented elements of the final 
amendments, the costs of implementing the final amendments will be 
lower than for firms that currently perform more limited audit 
procedures. For example, some firms employ procedures to reach and 
document their understanding with an auditor's specialist about, among 
other things, the responsibilities of the auditor's specialist and the 
nature of the work to be performed. Firms that do not already employ 
such procedures may incur additional costs under the final amendments.
    Similarly, the incremental impact of the final amendments on costs 
incurred by auditors would likely vary depending on, among other 
things, how many of an audit firm's engagements involve the use of the 
work of specialists. Among audit firms that use the work of specialists 
on their engagements, the anticipated costs would likely be higher for 
those firms that use the work of specialists more frequently or 
extensively than for firms that do so less frequently or extensively. 
Larger audit firms generally perform a larger number of audit 
engagements, however, and the incremental impact of the final 
amendments on their costs per engagement should be lower than for 
smaller firms that generally perform a smaller number of audit 
engagements. This would be the case regardless of whether the audit 
engagements of the larger and smaller firms involve the use of the work 
of specialists, since larger firms, due to their existing economies of 
scale \173\ and scope,\174\ would tend to be able to distribute the 
overall cost impact of the final amendments over a larger number of 
audit engagements.
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    \173\ See Economies of Scale and Scope, The Economist, Oct. 20, 
2008 (available at https://www.economist.com/news/2008/10/20/economies-of-scale-and-scope) (``Economies of scale are factors that 
cause the average cost of producing something to fall as the volume 
of its output [i.e., number of audit engagements] increases.''). In 
this context, the average cost would likely fall with the number of 
audit engagements, because certain costs, such as the cost of 
employing specialists, are not directly related to the number of 
audit engagements that an auditor assumes. See also Simon Yu Kit 
Fung, Ferdinand A. Gul, and Jagan Krishnan, City-Level Auditor 
Industry Specialization, Economies of Scale, and Audit Pricing 87 
The Accounting Review 1281, 1287 (2012) (``For an audit firm, the 
scale economies can arise from substantial investment in general 
audit technology (e.g., audit software development or hardware 
acquisition) and human capital development (e.g., staff training), 
which are likely to be shared among all of their clients. Once these 
investments are in place, additional clients can be serviced at a 
lower marginal cost than the cost of servicing the first few 
clients.'').
    \174\ See Economies of Scale and Scope, The Economist 
(``[E]conomies of scope [are] factors that make it cheaper to 
produce a range of products together than to produce each one of 
them on its own. Such economies can come from businesses sharing 
centralised functions . . .'').
---------------------------------------------------------------------------

    Some commenters argued that the Proposal could lead, in some 
instances, to significant (and potentially pervasive) increases in 
auditing costs, due to increased audit effort that would not 
necessarily be accompanied by corresponding increases in audit quality. 
In contrast, one commenter asserted that the requirements could be 
implemented effectively with minimal costs. In adopting the final 
amendments, the Board modified certain of the proposed amendments with 
the intent that the final amendments be risk-based and scalable, and 
that any cost increases be accompanied by commensurate improvements in 
audit quality. For example, as discussed earlier in this subsection, 
the final amendments reflect changes to the Proposal relating to the 
auditor's evaluation of the data, significant assumptions, and methods 
used by the company's specialist. These changes clarify that the focus 
of the auditor's evaluation does not require reperforming the 
specialist's work and thus should limit incremental costs to situations 
where more auditor involvement is necessary to address the identified 
risk of material misstatement.
    The final amendments might result in additional costs for some 
companies, compared to costs incurred under current requirements, to 
the extent that the final amendments lead auditors to raise their audit 
fees.\175\ Such additional costs could vary for the same reasons as 
described above relating to the final amendments' potential impact on 
costs incurred by auditors. The final amendments could also give rise 
to new recurring costs for management, to the extent that the final 
amendments result in the need for companies to devote more time and 
resources to respond to auditor inquiries and requests. Some commenters 
on the Proposal expressed concern about the potential cost to 
companies, including smaller companies. For example, one commenter 
suggested that companies might need to provide more support for their 
discount rate assumptions under the proposed amendments. On the other 
hand, another commenter suggested that, in the context of the size of 
the U.S. fixed income market, consistent use of methodologies compliant 
with fair value accounting requirements by companies would be a small 
cost to bear.
---------------------------------------------------------------------------

    \175\ It is not clear to what extent the final amendments will 
result in higher audit fees. The Board is aware of public reports 
that have analyzed historical and aggregate data on audit fees and 
suggest that audit fees generally have remained stable in recent 
years, notwithstanding the fact that the Board and other auditing 
standard setters have issued new standards and amended other 
standards during that period. See, e.g., Audit Analytics, Audit Fees 
and Non-Audit Fees: A Fifteen Year Trend (Dec. 2017). For a general 
discussion of cost pass-through, see, e.g., James Bierstaker, Rich 
Houston, Arnold Wright, The Impact of Competition on Audit Planning, 
Review, and Performance, 25 Journal of Accounting Literature 1, 12 
(2006) (summarizing research on the market for audit services and 
finding ``there is evidence of lower fee premiums when clients 
switch auditors, suggesting that auditors are less able to pass on 
the increased costs associated with new audits in a more competitive 
environment''); and RBB Economics, Brief 48: The Price Effect of 
Cost Changes: Passing Through and Here to Stay 1, 3 (Dec. 2014).
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    For many companies (and, indirectly, investors), however, the final 
amendments should not result in significant additional costs or 
significantly increased audit fees, particularly recurring costs, as 
their auditors, especially if they are larger audit firms, may have 
already incorporated many or all elements of the final amendments into 
their audit methodologies, and individual engagement teams may already 
be applying many or all of the final amendments in practice. In 
addition, the changes from the Proposal reflected in the final 
amendments, which clarify the auditor's responsibility when evaluating 
the work of the company's specialist, should mitigate some of the 
potential additional costs suggested by commenters.
Unintended Consequences
    In addition to the benefits and costs discussed above, the final 
amendments could have unintended economic impacts, the possibility of 
which the Board has taken into account in adopting the final 
amendments. The discussion below describes the potential unintended 
consequences that were identified in the Proposal or by commenters, as 
well as the Board's consideration of such consequences in adopting the 
final amendments. The discussion also addresses, where applicable, 
factors that mitigate the potential negative consequences, including 
revisions to the proposed amendments reflected in the final amendments 
and the existence of other countervailing factors.
Potential Adverse Impact on the Ability of Smaller Firms To Provide 
Audit Services
    In instances where the final amendments would increase the need of 
some audit firms to use the work of an auditor's specialist (rather 
than only use the work of a company's specialist under existing AS 
1210), the final amendments might result in some smaller firms 
accepting fewer audit engagements that would require the use

[[Page 13478]]

of an auditor's specialist. Relatedly, in such instances, some smaller 
firms might be inhibited from expanding their audit services for 
similar reasons. The Board had acknowledged the possibility of such 
unintended consequences in the Proposal, and some commenters also 
expressed the view that the proposed amendments might adversely impact 
the ability of smaller firms to provide audit services in certain 
situations.
    In particular, to the extent that auditors at smaller audit firms 
have less experience evaluating the work of a company's specialist than 
auditors at larger firms, some auditors may have an increased need to 
use the work of an auditor's specialist for certain engagements. 
Potentially, such firms would be unable to take advantage of the 
economies of scale and scope available to larger firms (for example, if 
they did not employ their own specialists and had to identify and 
engage qualified specialists), and find it economically less attractive 
to accept such engagements. In addition, some commenters on the 
Proposal suggested more broadly that the ability of smaller firms to 
compete in the audit services market would be adversely affected. The 
Board acknowledges that the final amendments could have a more 
significant impact on smaller firms than on larger firms. However, the 
Board believes that two factors will lessen any such adverse impact of 
the final amendments on smaller firms.
    First, as described earlier in this section, the evidence from 
PCAOB inspections data indicates that smaller audit firms generally 
have comparatively few audit engagements in which they use the work of 
a company's specialist or an auditor's specialist. For example, the 
results for smaller audit firms in Figure 5 above indicate that the 
auditors did not use the work of either a company's specialist or an 
auditor's specialist in 81% and 94% of the audits of smaller audit 
firms--U.S. and non-U.S. firms, respectively--inspected in 2017, and 
that the auditors used the work of a company's specialist without also 
using the work of an auditor's specialist \176\ in only 10% and 6% of 
the audits of smaller audit firms--U.S. and non-U.S. firms, 
respectively--inspected in 2017.\177\ These results suggest that the 
number of engagements where smaller firms might be faced with using an 
auditor's specialist for the first time to evaluate the work of a 
company's specialist under the final amendments is a relatively small 
proportion of audits subject to the Board's standards.
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    \176\ The fact that the auditor did not use the work of an 
auditor's specialist does not imply that the auditor should have 
used the work of an auditor's specialist.
    \177\ Furthermore, given that the engagements selected for 
inspection are on average more likely to be complex (and thus more 
likely to involve the use of the work of a specialist) than the 
overall population of audit engagements of smaller audit firms, the 
percentage results shown above for audits involving the use of the 
work of specialists are likely greater than the actual percentage of 
the overall population of audit engagements of smaller audit firms.
---------------------------------------------------------------------------

    Second, there is some evidence that smaller and larger audit firms 
do not directly compete with one another in some segments of the audit 
market.\178\ To the extent smaller audit firms compete in different 
segments of the audit market than larger audit firms, the competitive 
impact of the final amendments on smaller firms would be lessened.
---------------------------------------------------------------------------

    \178\ See, e.g., GAO Report No. GAO-03-864, Public Accounting 
Firms: Mandated Study on Consolidation and Competition (July 2003).
---------------------------------------------------------------------------

    Taking into consideration the factors described above, the final 
amendments further mitigate the potential adverse impact on the ability 
of smaller firms to provide audit services involving, or compete for 
audit engagements that require, the use of the work of specialists. For 
example, the clarifications in the final amendments for evaluating the 
work of a company's specialist, such as limiting the use of the term 
``test'' to procedures applied to company-produced information used by 
the specialist, should alleviate concerns expressed by certain 
commenters on the Proposal that auditors would be required to reperform 
the work of a company's specialist. In addition, under the final 
amendments, auditors are allowed to assess the objectivity of an 
auditor-engaged specialist along a spectrum, rather than make a binary 
determination whether they can use the work of an auditor-engaged 
specialist.\179\
---------------------------------------------------------------------------

    \179\ Similarly, the final amendments recognize that a company's 
ability to significantly affect the judgments of a company's 
specialist may vary and provide for the auditor to evaluate along a 
spectrum the company's ability to significantly affect those 
judgments.
---------------------------------------------------------------------------

Potential Diversion of Auditor Attention From Other Tasks That Warrant 
Attention
    In some audit engagements involving specialists, the final 
amendments might lead auditors to devote more of their attention and 
resources to the work of a company's specialists (including the related 
training of audit personnel) and to enhancing the coordination with an 
auditor's specialists, and less time and resources to other tasks that 
warrant greater attention.
    The potential impact on overall audit quality might vary as the re-
orientation of attention would occur in different ways for each audit 
engagement. Any potential adverse impact on overall audit quality is 
mitigated, however, by the risk-based approach in the final amendments 
to using the work of specialists. To the extent that the re-orientation 
of the auditor's attention leads to more effort in areas with the 
greatest risk of material misstatement to the financial statements, 
overall audit quality would be expected to increase. Furthermore, if 
auditors devote more attention to the work of specialists and enhancing 
the coordination with their specialists, the final amendments will 
result in some auditors acquiring greater expertise, which could 
positively affect the quality of audit work performed by such auditors. 
Such auditor specialization could lead some audit firms to seek fewer 
audit engagements involving specialists, while other firms might seek 
more such engagements. In such a market, the competitive effects of 
increased specialization would likely be highly dependent on the 
circumstances.
Potential for Unnecessary Effort by the Auditor or the Auditor's 
Specialist
    Under the final amendments, the potential exists that auditors 
might interpret the final requirements to suggest that they should use 
the work of an auditor's specialist in situations where the auditor had 
already obtained sufficient appropriate evidence with respect to a 
relevant assertion of a significant account or disclosure. The Proposal 
also identified this potential consequence, and some commenters 
expressed concern that auditors might feel compelled to do more work 
than was necessary or optimal under the proposed requirements. This 
unintended consequence might also arise under the final amendments if 
an auditor had already evaluated the work of a company's specialist, 
but decided to employ or engage its own specialist to perform 
additional procedures. For example, the auditor might ask an auditor's 
specialist to develop or assist in developing an independent 
expectation of an estimate in order to further demonstrate his or her 
diligence or err on the side of caution. In some instances, it is 
possible that the auditor might do so even though the auditor believes 
the costs of using the work of an auditor's specialist will outweigh 
the expected benefits in terms of audit quality.
    The final amendments, however, mitigate this risk in several 
respects. In particular, the final amendments do not require the 
auditor to use the work of an

[[Page 13479]]

auditor's specialist. Moreover, the final amendments regarding the 
nature, timing, and extent of the evaluation of the work of the 
company's specialist are designed to be risk-based and scalable to 
companies of varying size and complexity. In addition, as discussed 
above, the final amendments clarify the requirements for evaluating the 
work of a company's specialist and assessing the objectivity of an 
auditor-engaged specialist, which should avoid unnecessary effort by 
the auditor or auditor's specialist. Accordingly, any increases in 
effort should be accompanied by improvements in audit quality.
Potential Shift in the Balance Between the Work of a Company's 
Specialist and the Work of an Auditor's Specialist
    In audit engagements involving specialists, the potential exists 
that the final amendments could affect the balance between the work of 
a company's specialist and the work of an auditor's specialist. The 
Proposal also identified this potential consequence, and some 
commenters expressed concern that companies might, in some instances, 
choose not to engage or involve a company's specialist if they expected 
that the auditor would use an auditor's specialist to perform 
additional procedures.\180\
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    \180\ See, e.g., Letter from Duff & Phelps (Aug. 30, 2017), at 
4, available on the Board's website in Docket 044 (``situations may 
arise where management may feel compelled to invest less time, costs 
and effort in supporting certain assertions in the financial 
statements by not engaging a specialist when one would otherwise be 
called for--especially given the expectation that the auditor's 
specialist would perform extensive testing and calculations as part 
of the audit'').
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    The final amendments do not change management's responsibility for 
the financial statements or their obligation to maintain effective 
internal control over financial reporting. Anticipating the use of an 
auditor's specialist for the audit engagement, however, some issuers 
may decide to use a company's specialist to a lesser extent (or not at 
all) when preparing financial statements and some company specialists 
may exhibit a reduced sense of responsibility. In such instances, the 
auditor's specialist may have to perform more work in order to 
adequately evaluate potential audit evidence provided by the issuer, 
including the work of a company's specialist if the issuer continues to 
use such a specialist. Alternatively the auditor may decide not to use 
the work of a company's specialist or use that work to a lesser extent. 
If the situations described above were to occur, audit quality might be 
reduced, not enhanced, in some instances.
    The change in the balance between the work of a company's 
specialist and the work of an auditor's specialist, however, would 
likely be limited, as companies control the work of a company's 
specialist over information to be used in the financial statements, but 
lack similar control over an auditor's specialist. Companies generally 
are likely, therefore, to prefer to continue their use of a company's 
specialist. In addition, the final amendments do not require auditors 
to use an auditor's specialist when using the work of a company's 
specialist. Moreover, compared to the Proposal, the final amendments 
clarify the requirements for evaluating the work of a company's 
specialist. For example, the final amendments clarify the auditor's 
responsibilities for evaluating the methods and significant assumptions 
used by the company's specialist, and limit the use of the term 
``test'' to procedures applied to company-produced information used by 
the specialist. These clarifications should alleviate concerns 
expressed by certain commenters.
Potential Reduction in the Availability of Specialists
    Some commenters on the Proposal suggested that the proposed 
amendments, if adopted, would not affect the pool of qualified 
specialists available to serve as auditors' specialists. Other 
commenters, however, expressed concern that the proposed amendments 
might result in a shortage of, or strains on, the pool of qualified 
auditors' specialists, especially in situations where an audit firm 
currently uses the work of a company's specialist, but does not 
concurrently use an auditor's specialist.\181\ Situations that involved 
the auditor's use of the work of a company's specialist, but did not 
concurrently involve the use of an auditor's specialist, comprised a 
small percentage of audit engagements, ranging from 6% to 10% of the 
audit engagements of smaller and larger audit firms--U.S. and non-
U.S.--that were selected for inspection in 2017 (category (1) of Figure 
5 above).
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    \181\ Commenters did not specify whether such shortages would be 
permanent, or instead would reflect a temporary disruption to which 
the market would adjust over time.
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    Similar to the proposed amendments, the final amendments do not 
require auditors to use an auditor's specialist when using the work of 
a company's specialist. Moreover, in comparison to the proposed 
amendments, auditors are allowed under the final amendments to assess 
the objectivity of an auditor-engaged specialist along a spectrum, 
rather than make a binary determination whether they can use the work 
of an auditor-engaged specialist.\182\ This change should also reduce 
the possibility of a shortage of qualified auditors' specialists. 
Accordingly, the Board believes that the final amendments should not 
result in a shortage of, or strains on, the pool of qualified 
specialists available to serve as auditors' specialists.
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    \182\ Additionally, the final amendments provide for the auditor 
to evaluate along a spectrum the company's ability to significantly 
affect the judgments of the company's specialist. Furthermore, as 
discussed above, the final amendments reflect changes to the 
Proposal relating to the evaluation of the data, significant 
assumptions, and methods used by the company's specialist that 
clarify that the focus of the auditor's evaluation does not require 
the auditor to reperform the specialist's work.
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Alternatives Considered, Including Key Policy Choices
    The development of the final amendments involved considering a 
number of alternative approaches to address the problems described 
above. This subsection explains: (1) Why standard setting is preferable 
to other policy-making approaches, such as providing interpretive 
guidance or enhancing inspection or enforcement efforts; (2) other 
standard-setting approaches that were considered by the Board; and (3) 
key policy choices made in determining the details of the proposed 
standard-setting approach.
Why Standard Setting Is Preferable to Other Policy-Making Approaches
    The Board's policy tools include alternatives to standard setting, 
such as issuing additional interpretive guidance or an increased focus 
on inspections or enforcement of existing standards. One commenter 
stated that the Board should be proactive and supported the Board's 
preference for standard setting over other policy tools, while other 
commenters noted that other policy tools, such as the issuance of staff 
guidance and inspections activity, should also be considered.
    While other policy tools may complement auditing standards, the 
Board has determined that providing additional guidance or increasing 
its inspection or enforcement efforts, without also amending the 
existing requirements regarding the auditor's responsibilities for 
using the work of specialists, would not be effective corrective 
mechanisms to address concerns with the evaluation of the work of a 
company's specialist, the

[[Page 13480]]

supervision of an auditor's specialists, and the sources of market 
failure discussed previously. In addition, while devoting additional 
resources to such activities might focus auditors' attention on 
existing requirements, it would not provide the benefits associated 
with improving the standards discussed above. Thus, the final approach 
reflects the conclusion that standard setting is needed to fully 
achieve the benefits resulting from improvement in audits involving 
specialists. The Board will, however, monitor the implementation of the 
final amendments by audit firms and, if appropriate, consider the need 
for additional guidance.
Other Standard-Setting Alternatives Considered
    Several alternative standard-setting approaches were also 
considered, including: (1) Retaining the existing framework but 
requiring the auditor to disclose when the auditor used the work of 
specialists in the audit; or (2) targeted amendments to existing 
requirements.
Disclosing When the Work of a Specialist Is Used
    As an alternative to amending AS 1105 and AS 1201 and replacing 
existing AS 1210 in its entirety, the Board considered amending 
existing AS 1210 to remove the current limitations in existing AS 
1210.15 on disclosing that a specialist was involved in the audit. 
Under this approach, the auditor would have been required to disclose 
this fact. Investors might benefit from such a requirement, since it 
would inform investors, at a minimum, that the auditor had evaluated 
the need for specialized skill or knowledge in order to perform an 
audit in accordance with PCAOB standards. Such disclosures could, in 
theory, positively affect audit practice, as auditors might face more 
scrutiny from investors regarding their decisions whether or not to use 
specialists.
    Disclosure alone, however, would be unlikely to achieve the Board's 
objectives, which includes effecting more consistently rigorous 
practices among auditors when using the work of a company's specialist 
in their audits, as well as effecting a more consistent approach to the 
supervision of auditor-employed and auditor-engaged specialists. For 
example, with disclosure alone, some auditors might not evaluate the 
significant assumptions and methods of a company's specialist, even in 
higher risk audit areas.
    Moreover, in a separate rulemaking, the Board has adopted a new 
auditing standard that requires the auditor to communicate CAMs in the 
auditor's report. A CAM is defined as any matter arising from the audit 
of the financial statements that was communicated or required to be 
communicated to the audit committee and that relates to accounts or 
disclosures that were material to the financial statements and involved 
especially challenging, subjective, or complex auditor judgment.\183\ 
Depending on the circumstances, the description of such CAMs might 
include a discussion of the work or findings of a specialist. While it 
is not yet clear how frequently the use of the work of specialists will 
be disclosed in the auditor's report as part of CAMs, these disclosure 
requirements are complemented by amending AS 1105 and AS 1201 and 
replacing existing AS 1210 to improve performance requirements over the 
use of the work of specialists. As discussed above, this should 
directly mitigate auditor moral hazard and change certain elements of 
audit practice observed by PCAOB oversight activities that have given 
rise to concern, such as situations where auditors did not apply 
appropriate professional skepticism when using the work of specialists.
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    \183\ See The Auditor's Report on an Audit of Financial 
Statements When the Auditor Expresses an Unqualified Opinion and 
Related Amendments to PCAOB Standards, PCAOB Release No. 2017-001 
(June 1, 2017).
---------------------------------------------------------------------------

Targeted Amendments to Existing Requirements for Using the Work of an 
Auditor's Specialists
    The Board considered, but is not adopting, two alternative 
approaches for an auditor's use of the work of an auditor's specialist, 
as discussed in further detail in the Proposal. The first alternative 
was to develop a separate standard for using the work of an auditor's 
specialist. This approach would have created a new auditing standard 
for using the work of an auditor's specialist, whether employed or 
engaged by the auditor, similar to the approach in ISA 620 and AU-C 
Section 620 (and thereby separating the requirements for using the work 
of an auditor-engaged specialist from those for using the work of a 
company's specialist). One commenter on the Proposal supported this 
approach. The second alternative was to extend the supervisory 
requirements in AS 1201 to an auditor-engaged specialist. This approach 
would have amended existing AS 1210 to remove all references to an 
auditor-engaged specialist and amended AS 1201 to include all 
arrangements involving auditor-employed and auditor-engaged 
specialists.
    Given the similar role of an auditor-employed and an auditor-
engaged specialist in the audit, the Board determined that the 
auditor's procedures for reaching an understanding with the specialist 
and evaluating the work to be performed by the specialist should be 
similar. Accordingly, the Board has adopted separate, but parallel, 
requirements for using the work of an auditor-employed specialist and 
an auditor-engaged specialist related to reaching an understanding and 
evaluating the work to be performed. However, as discussed above, the 
auditor's relationship to an auditor-employed specialist differs in 
certain respects from the auditor's relationship to an auditor-engaged 
specialist, which may affect the auditor's visibility into the 
specialist's knowledge, skill, and ability, as well as into any 
relationships that might affect the specialist's independence or 
objectivity. Accordingly, the final amendments address these 
differences by requiring the auditor to perform procedures in AS 1210, 
as amended, to evaluate the knowledge, skill, ability, and objectivity 
of auditor-engaged specialists, while recognizing that the auditor 
evaluates the knowledge, skill, ability, and independence of auditor-
employed specialists in accordance with the same requirements that 
apply to other engagement team members.
Key Policy Choices
    Given the preference for creating separate requirements for using a 
company's specialist, an auditor-employed specialist, and an auditor-
engaged specialist, the Board considered different approaches to 
addressing key policy issues.
Scope of the Final Amendments
    The Board considered a variety of possible approaches to the scope 
of the final amendments, including the treatment of persons with 
specialized skill or knowledge in certain areas of IT and income taxes. 
See section C for a discussion of the Board's considerations. In 
particular, after considering comments on the Proposal, the Board has 
clarified the scope and application of the final amendments in the rule 
text and discussion in its adopting release. The Board, while mindful 
of advances in technology that could fundamentally impact the audit 
process (and hence what is understood to be skill and knowledge in 
specialized areas of accounting and auditing), believes that the final 
amendments are sufficiently principles-based and flexible to 
accommodate continued technological advances that could impact audit 
practice in the future.

[[Page 13481]]

Evaluating the Work of a Company's Specialist
    The Board considered a variety of possible approaches relating to 
the auditor's evaluation of the work of a company's specialist. See 
section C for a discussion of the Board's considerations. In 
particular, after considering the comments on the Proposal, the Board 
is retaining the fundamental approach in the Proposal, under which the 
auditor evaluates the data, significant assumptions, and methods used 
by the specialist. The final amendments, including the revisions to the 
proposed requirements described in section C, retain the benefits 
resulting from the use of a risk-based audit approach, while at the 
same time directing the auditor to consider the quality of the source 
of information when determining his or her audit approach.
Evaluating the Qualifications and Independence of the Auditor-Employed 
Specialist
    The Board considered a variety of possible approaches to evaluating 
the knowledge, skill, ability, and independence of auditor-employed 
specialists. See section C for a discussion of the Board's 
considerations. In particular, after considering the comments on the 
Proposal, the Board eliminated from the final amendments certain 
paragraphs that could have been misinterpreted as suggesting a 
different process for evaluating the qualifications and independence of 
auditor-employed specialists than for other engagement team members. 
Instead, the final amendments acknowledge that an auditor-employed 
specialist is a member of the engagement team and that existing 
requirements for assessing the qualifications and independence of 
engagement team members apply equally to auditor-employed specialists.
Assessing the Qualifications and Objectivity of the Auditor-Engaged 
Specialist
    The Board considered a variety of possible approaches to assessing 
the knowledge, skill, ability, and objectivity of auditor-engaged 
specialists. See section C for a discussion of the Board's 
considerations. In particular, after considering the comments, the 
Board made revisions in adopting the requirements described in section 
C to allow auditors to assess the objectivity of auditor-engaged 
specialists along a spectrum, rather than make a binary determination. 
The Board believes the final amendments in this area should limit any 
incremental cost to circumstances where increases in audit quality can 
be reasonably expected and thereby mitigate any adverse economic impact 
from potential unintended consequences of the final amendments. For 
example, requiring the auditor to perform additional procedures to 
evaluate the data, significant assumptions, and methods used by the 
specialist when the specialist has a relationship with the company that 
affects the specialist's objectivity should increase audit quality and 
reduce the risk that a material misstatement could go undetected.
Special Considerations for Audits of Emerging Growth Companies
    Pursuant to Section 104 of the Jumpstart Our Business Startups 
(``JOBS'') Act, rules adopted by the Board subsequent to April 5, 2012, 
generally do not apply to the audits of EGCs, unless the SEC 
``determines that the application of such additional requirements is 
necessary or appropriate in the public interest, after considering the 
protection of investors, and whether the action will promote 
efficiency, competition, and capital formation.'' \184\ As a result of 
the JOBS Act, the rules and related amendments to PCAOB standards the 
Board adopts are generally subject to a separate determination by the 
SEC regarding their applicability to audits of EGCs.
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    \184\ See Public Law 112-106 (Apr. 5, 2012). See Section 
103(a)(3)(C) of the Sarbanes-Oxley Act, as added by Section 104 of 
the JOBS Act. Section 104 of the JOBS Act also provides that any 
rules of the Board requiring (1) mandatory audit firm rotation or 
(2) a supplement to the auditor's report in which the auditor would 
be required to provide additional information about the audit and 
the financial statements of the issuer (auditor discussion and 
analysis) shall not apply to an audit of an EGC. The final 
amendments do not fall within either of these two categories.
---------------------------------------------------------------------------

    The Proposal sought comment on the applicability of the proposed 
requirements to audits of EGCs. Commenters generally supported applying 
the proposed requirements to audits of EGCs. These commenters asserted 
that consistent requirements should apply for similar situations 
encountered in any audit of a company, whether that company is an EGC 
or not, as well as that the benefits described in the Proposal would be 
applicable to EGCs. One commenter suggested ``phasing'' the 
implementation of the requirements for such audits to reduce the 
compliance burden.
    The Board also notes that any new PCAOB standards and amendments to 
existing standards determined not to apply to the audits of EGCs would 
require auditors to address the differing requirements within their 
methodologies, which would also create the potential for confusion.
    To inform consideration of the application of auditing standards to 
audits of EGCs, the PCAOB staff has also published a white paper that 
provides general information about characteristics of EGCs.\185\ As of 
the November 15, 2017 measurement date, the PCAOB staff identified 
1,946 companies that had identified themselves as EGCs in at least one 
SEC filing since 2012 and had filed audited financial statements with 
the SEC in the 18 months preceding the measurement date.
---------------------------------------------------------------------------

    \185\ See PCAOB white paper, Characteristics of Emerging Growth 
Companies as of November 15, 2017 (Oct. 11, 2018) (``EGC White 
Paper''), available on the Board's website.
---------------------------------------------------------------------------

    Overall, the discussion of benefits, costs, and unintended 
consequences above is generally applicable to audits of EGCs. EGCs 
generally tend to have shorter financial reporting histories than other 
exchange-listed companies. As a result, there is less information 
available to investors regarding such companies relative to the broader 
population of public companies.\186\
---------------------------------------------------------------------------

    \186\ Id.
---------------------------------------------------------------------------

    Although the degree of information asymmetry between investors and 
company management for a particular issuer is unobservable, researchers 
have developed a number of proxies that are thought to be correlated 
with information asymmetry, including small issuer size, lower analyst 
coverage, larger insider holdings, and higher research and development 
costs.\187\ To the extent that EGCs exhibit one or more of these 
properties, there may be a greater degree of information asymmetry for 
EGCs than for the broader population of companies, which increases the 
importance to investors of the external audit to enhance the 
credibility of management disclosures.\188\ The final amendments

[[Page 13482]]

relating to the auditor's use of the work of specialists, which are 
intended to enhance audit quality, could contribute to an increase in 
the credibility of financial statement disclosures by EGCs.
---------------------------------------------------------------------------

    \187\ See, e.g., David Aboody and Baruch Lev, Information 
Asymmetry, R&D, and Insider Gains, 55 Journal of Finance 2747 
(2002); Michael J. Brennan and Avanidhar Subrahmanyam, Investment 
Analysis and Price Formation in Securities Markets, 38 Journal of 
Financial Economics 361 (1995); Varadarajan V. Chari, Ravi 
Jagannathan, and Aharon R. Ofer, Seasonalities in Security Returns: 
The Case of Earnings Announcements, 21 Journal of Financial 
Economics 101 (1988); and Raymond Chiang, and P. C. Venkatesh, 
Insider Holdings and Perceptions of Information Asymmetry: A Note, 
43 Journal of Finance 1041 (1988).
    \188\ See, e.g., Molly Mercer, How Do Investors Assess the 
Credibility of Management Disclosures?, 18 Accounting Horizons 185, 
189 (2004) (``[Academic studies] provide archival evidence that 
external assurance from auditors increases disclosure credibility. . 
.These archival studies suggest that bankers believe audits enhance 
the credibility of financial statements . . .'').
---------------------------------------------------------------------------

    When confronted with information asymmetry, investors may require a 
larger risk premium, and thus increase the cost of capital to 
companies.\189\ Reducing information asymmetry, therefore, can lower 
the cost of capital to companies, including EGCs, by decreasing the 
risk premium required by investors.\190\
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    \189\ See supra notes 165 and 167.
    \190\ For a discussion of how increasing reliable public 
information about a company can reduce risk premium, see David 
Easley and Maureen O'Hara, Information and the Cost of Capital, 59 
The Journal of Finance 1553 (2004).
---------------------------------------------------------------------------

    Furthermore, an analysis by PCAOB staff, the results of which are 
summarized in Figure 6 below, suggests that the prevalence and 
significance of the use of the work of specialists in audits of EGCs is 
comparable to the prevalence and significance of the use of the work of 
specialists in audits of non-EGCs, for audit engagements by both 
smaller audit firms and larger audit firms.\191\
---------------------------------------------------------------------------

    \191\ The staff analysis was based on engagement-level data from 
the subset of 74 audit engagements of EGCs by U.S. and non-U.S. 
audit firms that were selected for inspection in 2017 presented 
above.

  Figure 6--Audits Performed by U.S. and Non-U.S. Audit Firms of EGCs That Were Selected for Inspection by the
                          PCAOB in 2017, Categorized by Use of the Work of Specialists
----------------------------------------------------------------------------------------------------------------
                                                                                                  % (number) of
                                            % (number) of     % (number) of     % (number) of       audits by
                                          audits by larger      audits by     audits by larger   smaller  audit
                                             audit firms     smaller  audit      audit firms      firms  (non-
                                               (U.S.)         firms  (U.S.)      (non-U.S.)           U.S.)
----------------------------------------------------------------------------------------------------------------
(1) auditor used the work of a company's            0% (0)            9% (3)           11% (1)           13% (1)
 specialist but did not use the work of
 an auditor's specialist................
(2) auditor used the work of an                     8% (2)            0% (0)           22% (2)            0% (0)
 auditor's specialist but did not use
 the work of a company's specialist.....
(3) auditor used the work of both a                29% (7)           12% (4)           22% (2)            0% (0)
 company's specialist and an auditor's
 specialist.............................
(4) auditor neither used the work of a            63% (15)          79% (26)           44% (4)           88% (7)
 company's specialist nor used an
 auditor's specialist \192\.............
                                         -----------------------------------------------------------------------
    Total \193\.........................         100% (24)         100% (33)          100% (9)          100% (8)
----------------------------------------------------------------------------------------------------------------
Source: PCAOB

    As indicated in Figure 6, the staff analysis observed that 41 (or 
about 55%) of the audit engagements were performed by U.S. and non-
U.S., smaller audit firms. Among those 41 audit engagements, only four 
(or about 10%) involved the use of the work of a company's specialist 
but did not concurrently involve the use of the work of an auditor's 
specialist (category (1) above). In comparison, 33 of the 41 audit 
engagements (or about 80%) did not involve the use of the work of 
either a company's specialist or an auditor's specialist (category (4) 
above) and four of the 41 audit engagements (or about 10%) involved the 
use of both a company's specialist and an auditor's specialist 
(category (3) above). In none of those 41 audit engagements did the 
auditor use the work of an auditor's specialist without also 
concurrently using the work of a company's specialist (category (2) 
above). Among the 33 audit engagements of EGCs (or about 45%) performed 
by larger firms, both U.S. and non-U.S. firms, one (or about 3%) 
involved the use of the work of a company's specialist but did not 
concurrently involve the use of the work of an auditor's specialist 
(category (1) above); 19 (or about 58%) did not involve the use of the 
work of either a company's specialist or an auditor's specialist 
(category (4) above); nine (or about 27%) involved the use of both a 
company's specialist and an auditor's specialist (category (3) above); 
and four (or about 12%) involved the use of the work of an auditor's 
specialist, but did not concurrently involve the use of work of a 
company's specialist (category (2) above).
---------------------------------------------------------------------------

    \192\ The audit engagements not included in the preceding three 
categories were included in the fourth category.
    \193\ The total for the values shown in categories (1) through 
(4) may not add to 100% due to rounding.
---------------------------------------------------------------------------

    Thus, the Board believes that the need for the final amendments 
discussed earlier and the associated benefits of the final amendments 
generally apply also to audits of EGCs.
    While for small companies (including EGCs), even a small increase 
in audit fees could negatively affect their profitability and 
competitiveness, many EGCs are expected to experience minimal impact 
from the final amendments. In particular, some EGCs do not use a 
company's specialist and, for those EGCs that do use a company's 
specialist, the final amendments relating to the auditor's use of the 
work of such specialists are risk-based and designed to be scalable to 
companies of varying size and complexity.
    In addition, the analysis presented in the EGC White Paper observed 
that about 40% of audits of EGCs are performed by firms that provided 
audit reports for more than 100 issuers and were required to be 
inspected on an annual basis by the PCAOB.\194\ These firms tend to 
already have practices for using the work of specialists that are 
consistent with many or all elements of the final amendments. For such 
audit firms, the costs on a per engagement basis of adopting the final 
amendments should also be low, for the reasons discussed above.
---------------------------------------------------------------------------

    \194\ See EGC White Paper, at 3.
---------------------------------------------------------------------------

    For the other 60% of audits of EGCs, the PCAOB staff analysis 
summarized in Figure 6 above suggests that the proportion of EGC audit 
engagements that involve the use of the work of company specialists, 
but do not involve the use of the work of an auditor's specialist, is 
small and comparable to the proportion of similar issuer audit 
engagements described previously. As discussed above, auditors on such 
audit engagements may experience the most significant cost impact of 
the final amendments. However, only a small proportion of audits of 
EGCs are expected to be significantly affected by the final amendments. 
In addition, the final amendments clarify the requirements for 
evaluating the work of a company's specialist and assessing the 
objectivity of an auditor-engaged specialist, which should avoid

[[Page 13483]]

unnecessary effort by the auditor or auditor's specialist. Accordingly, 
any increase in effort should be accompanied by improvements in audit 
quality.
    The Board has provided this analysis to assist the SEC in its 
consideration of whether it is ``necessary or appropriate in the public 
interest, after considering the protection of investors and whether the 
action will promote efficiency, competition, and capital formation,'' 
to apply the final amendments to audits of EGCs. This information 
includes data and analysis of EGCs identified by the Board's staff from 
public sources.
    For the reasons explained above, the Board believes that the final 
amendments are in the public interest and, after considering the 
protection of investors and the promotion of efficiency, competition, 
and capital formation, recommends that the final amendments should 
apply to audits of EGCs. Accordingly, the Board recommends that the 
Commission determine that it is necessary or appropriate in the public 
interest, after considering the protection of investors and whether the 
action will promote efficiency, competition, and capital formation, to 
apply the final amendments to audits of EGCs. The Board stands ready to 
assist the Commission in considering any comments the Commission 
receives on these matters during the Commission's public comment 
process.
Applicability to Audits of Brokers and Dealers
    The Proposal indicated that the proposed amendments would apply to 
audits of brokers and dealers, as defined in Sections 110(3)-(4) of the 
Sarbanes-Oxley Act. The Board solicited comment on any factors 
specifically related to audits of brokers and dealers that may affect 
the application of the proposed amendments to those audits. Commenters 
that addressed the issue agreed that amendments to the standards for 
the auditor's use of the work of specialists should apply to these 
audits, citing benefits to users of financial statements of brokers and 
dealers and the risk of confusion and inconsistency if different 
methodologies were required under PCAOB standards for audits of 
different types of entities.
    After considering comments, the Board determined that the final 
amendments, if approved by the SEC, will be applicable to all audits 
performed pursuant to PCAOB standards, including audits of brokers and 
dealers. The Board's determination is based on the observation that the 
information asymmetry between the management of brokers and dealers and 
their customers about the brokers' and dealers' financial condition may 
be significant and of particular interest to customers, as a broker or 
dealer may have custody of customer assets, which could become 
inaccessible to the customers in the event of the insolvency of the 
broker or dealer.
    In addition, unlike the owners of brokers and dealers, who 
themselves may be managers and thus be subject to minimal or no 
information asymmetry, customers of brokers and dealers may, in some 
instances, be large in number and may not be expert in the management 
or operation of brokers and dealers. Such information asymmetry between 
the management and the customers of brokers and dealers makes the role 
of auditing important to enhance the reliability of financial 
information.
    Accordingly, the discussion above of the need for the final 
amendments, as well as the costs, benefits, alternatives considered and 
potential unintended consequences to auditors and the companies they 
audit, also applies to audits of brokers and dealers. In particular, 
PCAOB staff analysis of inspections data for audits of brokers and 
dealers indicates that auditors of brokers and dealers do not 
frequently use the work of specialists, whether company specialists or 
an auditor's specialists.\195\ Hence, the results suggest that only a 
small percentage of audits of brokers and dealers will be impacted by 
the final amendments. In addition, with respect to the impact of the 
final amendments on customers of brokers and dealers, the expected 
improvements in audit quality described previously would benefit such 
customers, along with investors, capital markets and auditors, while 
the final requirements are not expected to result in any direct costs 
or unintended consequences to customers of brokers and dealers.
---------------------------------------------------------------------------

    \195\ The staff analysis is based on 116 audit engagements of 
brokers and dealers performed by audit firms that were selected for 
inspection in 2017. The results of the analysis found that the 
auditor did not use the work of a specialist in about 90% of the 
broker or dealer audits. This analysis also found that auditors used 
the work of at least one auditor's specialist in about 8% of the 
audits analyzed and used the work of at least one company specialist 
in about 2% of those audits.
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III. Date of Effectiveness of the Proposed Rules and Timing for 
Commission Action

    Pursuant to Section 19(b)(2)(A)(ii) of the Exchange Act, and based 
on its determination that an extension of the period set forth in 
Section 19(b)(2)(A)(i) of the Exchange Act is appropriate in light of 
the PCAOB's request that the Commission, pursuant to Section 
103(a)(3)(C) of the Sarbanes-Oxley Act, determine that the proposed 
rules apply to the audits of EGCs, the Commission has determined to 
extend to July 3, 2019 the date by which the Commission should take 
action on the proposed rules.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed 
rules are consistent with the requirements of Title I of the Act. 
Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/pcaob.shtml); or
     Send an email to [email protected]. Please include 
File Number PCAOB-2019-03 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number PCAOB-2019-03. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's internet website (http://www.sec.gov/rules/pcaob.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rules that are filed 
with the Commission, and all written communications relating to the 
proposed rules between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for website viewing and printing in 
the Commission's Public Reference Room, on official business days 
between the hours of 10:00 a.m. and 3:00 p.m. Copies of such filing 
will also be available for inspection and copying at the principal 
office of the PCAOB. All comments received will be posted without 
charge. Persons submitting comments are cautioned that we do not redact 
or edit personal identifying information from comment submissions. You 
should submit only information that you wish to make available 
publicly. All submissions should refer to File Number PCAOB-2019-03 and

[[Page 13484]]

should be submitted on or before April 25, 2019.
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    \196\ 17 CFR 200.30-11(b)(1) and (3).

    For the Commission, by the Office of the Chief Accountant, by 
delegated authority.\196\
Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-06425 Filed 4-3-19; 8:45 am]
BILLING CODE 8011-01-P