GAAS v. PCAOB—Sorting it Out and Avoiding Liability

Source: Journal of Accountancy

Private company clients sometimes request CPAs to use both GAAS and PCAOB auditing standards. These clients, however, may not always understand the differences between the two. Jurors may have the same misunderstandings. The result can be litigation if the result of the audit is not successful. To avoid this, firms should adopt the following management practices:

• Set standards for acceptance of clients. These should include the firm’s ability to perform the engagement, independence and objectivity, integrity and financial soundness of the client, and the client’s commitment to good internal controls and financial reporting. Due diligence should be performed on the client and its principals.
• Determine who will use your reports. Some clients ask you to utilize some (but not all) PCAOB standards. Users might believe the resulting audit is superior to an audit conducted strictly according to GAAS. This can lead to greater expectations and potential litigation (and jurors sympathetic to the plaintiffs).

Using some or all PCAOB standards might or might not be necessary and appropriate for a private company. (A private company considering a public offering, or a sale to a public company.) The CPA firm should advise the client on what may or may not be appropriate. Clients should be informed that private companies are not required to use PCAOB standards and should be explained the differences between PCAOB and GAAS. If the client decides to use PCAOB standards, the auditor is required to use both.

If the client wants to use some PCAOB standards, it should know that not only may the cost exceed the benefit, but the outcome may reduce the company’s perceived strength.

If a third party requests PCAOB standards, and you think it is inappropriate, you may want to so inform the client and the third party.

• If the client asks for audit procedures not required by GAAS, be sure the engagement letter clearly indicates the audit is not a PCAOB audit.
• If the audit is conducted pursuant to both sets of standards, the engagement has added risk.
• Conduct a formal training program to educate everyone in the firm on the auditing standards. Partners and staff should be circumspect when communicating standards to clients, and all conversations should be documented.
• Engagement letters should include provisions that “demonstrate good faith and reduce liability.” Communicate clearly to clients what each set of standards does and does not do, and that audits of private companies pursuant to PCAOB standards do not include inspections or exercise of authority by PCAOB.
• Documentation under GAAS and PCAOB should be similar.

If a CPA firm uses PCAOB standards in conducting an audit, but is not registered with the PCAOB, it may be at greater risk in the event of litigation.

Public expectations of CPAs performance have significantly increased since the financial reporting failures in recent years. A recent survey of potential jurors shows that 70 percent believe CPAs are responsible for detecting fraud in a review engagement (up from 40 percent). This may seriously affect litigation outcomes.

From Journal of Accountancy, September 2005. For the complete article, click on the following link: http://www.aicpa.org/pubs/jofa/aug2005/rosario.htm.