When a second accounting firm works on a PCAOB audit, one question decides which standard applies: does the lead auditor take responsibility for that firm's work, or divide responsibility and refer to its report? If the lead auditor does not divide responsibility, the other firm is an "other auditor" supervised under AS 1201. If the lead auditor does divide responsibility, the other firm is a "referred-to auditor" and AS 1206 applies, with a reference in the lead auditor's report. AS 2101 sets the threshold for whether a firm can serve as lead auditor at all.
This post covers the PCAOB path. For the US GAAS equivalent, see our guides to group audits under AU-C 600 and component auditor instructions.
What do the terms mean?
AS 2101 Appendix A defines them.
- Lead auditor: the registered firm issuing the auditor's report, plus the engagement partner and engagement team members who are firm employees and assist with planning or supervision.
- Other auditor: a member of the engagement team who is not a partner or employee of the lead auditor or of a firm to which responsibility is divided, and the firm of which that person is a partner or employee. Other auditors are part of the engagement team.
- Referred-to auditor: a public accounting firm, other than the lead auditor, that audits the financial statements of one or more business units and issues a PCAOB-standards report to which the lead auditor refers in its own report.
Can my firm serve as lead auditor?
AS 2101.06A requires the engagement partner to determine whether the firm's participation is sufficient to carry out the lead auditor's responsibilities and report as such. The engagement partner takes into account, in combination:
- the importance of the locations or business units the firm audits, in quantitative and qualitative terms;
- the risks of material misstatement in the firm's portion compared with the portions handled by other auditors or referred-to auditors; and
- the extent of the firm's supervision of other auditors' work.
The paragraph adds one bright line. In an audit with referred-to auditors, the firm's participation ordinarily is not sufficient if the referred-to auditors, in aggregate, audit more than 50 percent of the company's assets or revenues. Paragraph .06B requires the lead auditor's involvement to be commensurate with the risks of material misstatement at the locations other auditors cover.
Which preliminary checks apply to every other auditor?
- Independence and ethics (AS 2101.06D). The lead auditor obtains an understanding of the other auditor's knowledge of SEC independence and PCAOB independence and ethics requirements and its experience applying them. It obtains and reviews written affirmations about the firm's policies, a written description of relationships that may reasonably be thought to bear on independence, and an affirmation of compliance with respect to the audit client.
- Registration (AS 2101.06G). If an other auditor plays a substantial role in preparing or furnishing the lead auditor's report, the lead auditor may use that work only if the other auditor is registered with the PCAOB. See PCAOB registration for CPA firms.
- Knowledge, skill and ability (AS 2101.06H). The lead auditor understands the capabilities of the other auditor's team members who assist with planning or supervision, obtains a written affirmation that they have them, and determines it can communicate with the other auditor and reach its audit documentation.
What does supervision of an other auditor require under AS 1201?
AS 1201.03 makes the engagement partner responsible for supervising all engagement team members, including those outside the partner's firm. Paragraphs .07 to .15 add the following for other auditors, with the extent set by the factors in paragraph .06 (the company's size and complexity, the nature of the assigned work, the risks of material misstatement, and the knowledge, skill and ability of the team members):
| Paragraph | Requirement |
|---|---|
| .08 | Inform the other auditor in writing of the scope of work: the procedures, the controls or accounts and disclosures to test, the identified risks of material misstatement to the consolidated statements tied to the location, tolerable misstatement, and any amount below which misstatements are clearly trivial |
| .09 | Obtain and review the other auditor's written description of planned procedures, at a level of detail the lead auditor sets |
| .10 | Decide whether changes to planned procedures are needed, and communicate them in writing |
| .11 | Obtain and review a written affirmation on whether the work was done per instructions and PCAOB standards, with an explanation of any exceptions |
| .12 | Direct the other auditor to provide specified documentation, at minimum that described in AS 1215.19, and review it |
| .13 | Determine whether the work followed instructions and whether more evidence is needed, including for a previously unidentified risk |
What does dividing responsibility require under AS 1206?
AS 1206.03 to .06 require the lead auditor to:
- determine that procedures test and evaluate the consolidation or combination of the referred-to auditor's units, including intercompany transactions;
- communicate its plan to divide responsibility to the referred-to auditor in writing;
- obtain a written representation that the referred-to auditor is independent under PCAOB and SEC requirements and duly licensed; and
- confirm that the referred-to auditor has represented that it audited and reported under PCAOB standards, is familiar with the relevant reporting framework, PCAOB standards and SEC reporting requirements, and is PCAOB-registered if it played a substantial role in the lead auditor's report or reported on a business unit that is itself an issuer, broker or dealer.
If the business unit uses a different reporting framework, one auditor must have audited the conversion adjustments and the report must say which. If division of responsibility is not possible, paragraph .07 gives three choices: perform the procedures on the business unit yourself, qualify or disclaim, or withdraw.
What must the report say?
Paragraph .08 requires the report to indicate the division of responsibility in the opinion and basis sections, identify the referred-to auditor by name and refer to its report, and disclose the magnitude of the portion audited, by dollar amounts or percentages of total assets, total revenues or other criteria. Paragraph .09 adds that if the referred-to auditor's report has a non-unqualified opinion or explanatory language, the lead auditor refers to it unless clearly trivial.
The model wording in Appendix B reads: "We did not audit the financial statements of B Company, a wholly-owned subsidiary, whose financial statements reflect total assets constituting XX percent and YY percent of consolidated assets... Those financial statements were audited by Firm ABC, whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for B Company, is based solely on the report of Firm ABC."
Worked example
A company has three significant business units outside the lead auditor's own work.
| Unit | Share of total assets | Share of revenue | Treatment |
|---|---|---|---|
| X, audited by Firm ABC | 31% | 27% | Referred-to auditor |
| Y, audited by Firm DEF | 23% | 25% | Referred-to auditor |
| Z, Firm GHI working under supervision | 12% | 14% | Other auditor, AS 1201 |
Referred-to auditors together cover 54% of assets (31 plus 23) and 52% of revenue (27 plus 25). Both exceed 50 percent, so under AS 2101.06A the lead auditor's participation ordinarily is not sufficient to serve as lead auditor. The firm would need to reduce the referred-to portion, for example by auditing unit Y itself. Unit Z does not count toward the test because the lead auditor supervises it.
Comparing with AU-C 600
AU-C 600 uses the term "referred-to auditor" for an auditor of a component's financial statements to whom the group report refers, and treats component auditors as part of the engagement team with no reference in the report (paragraphs .56, .59 and .71). AU-C 600.59 also requires the group report to state the magnitude of the portion audited by the referred-to auditor. AU-C 600.60 requires the referred-to auditor's express permission to name it and presentation of its report alongside the group report. AU-C 600 has no 50 percent line like AS 2101.06A.
Sources
- PCAOB, AS 1201, Supervision of the Audit Engagement (paragraphs .03 to .15): https://pcaobus.org/oversight/standards/auditing-standards/details/AS1201
- PCAOB, AS 1206, Dividing Responsibility for the Audit with Another Accounting Firm (paragraphs .01 to .09 and Appendix B): https://pcaobus.org/oversight/standards/auditing-standards/details/AS1206
- PCAOB, AS 2101, Audit Planning (paragraphs .06A to .06I and Appendix A): https://pcaobus.org/oversight/standards/auditing-standards/details/AS2101
- AICPA, AU-C Section 600 (paragraphs .56 to .61 and .71): https://www.aicpa-cima.com/resources/landing/aicpa-professional-standards
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