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New Peer Review Standards

California CPA magazine: October 2008

In April, the AICPA issued the new Standards for Performing and Reporting on Peer Reviews, which will be implemented for peer reviews commencing on or after Jan. 1, 2009. The AICPA Peer Review Board rewrote the standards with a focus on transparency, understandability and clarity—and the changes are substantial.

“I must admit, I had my doubts when I first heard of the proposal for the new peer review reporting model, and I questioned how the elimination of the letter of comments could lead to more transparency,” says Thomas J. Parry, chair of the California Peer Review Committee and a former member of the AICPA Peer Review Board.
“I realize now that few people, outside of those performing and overseeing peer reviews, understood the relevance of the comments contained in the letter. I believe that this new reporting model is easier for all users of peer review reports to understand.”
Firms will now receive peer review reports with a “pass,” “pass with deficiencies” or “fail” designation. In addition, the letter of comments will be eliminated, but some documentation of findings that do not affect the report will be retained until the next peer review. These changes were considered necessary for clarity and ease of understanding of the peer review reporting process.
The Big Picture
While peer review has been around since the late 1970s, it wasn’t until 1988 that AICPA members voted to make peer review mandatory. Since that time, a CPA firm has had to undergo peer review every three years for their partners and staff to maintain AICPA membership.

A peer review is only required if the firm provides services that fall within the peer review standards, such as audits, reviews, attest and compilation services of non-public companies. A peer review covers a one-year period and is conducted by an independent person: a “peer reviewer.”

AICPA membership, however, is not the only catalyst for peer review. There are 41 state boards of accountancy that require some form of peer review for licensing purposes. California is not among that group, but if you have licenses in states other than California, you may be affected.

In addition, the Government Accountability Office requires a peer review to be completed within three years from the date a firm begins its first audit under generally accepted government auditing standards. Generally, audits are performed under these standards if a governmental unit or nonprofit organization expends $500,000 or more in a year in federal awards.

California law also can require audits of certain governmental units, such as California redevelopment agencies, to be performed under government auditing standards. Contracts with state departments, cities, counties or other grantors also may have a clause requiring that the audits be performed under these standards.
The new standards merge the AICPA Peer Review Program and the Center for Public Company Audit Firms (CPCAF) Peer Review Program. This is a natural progression of the changes that occurred in 2004 when the Public Company Accounting Oversight Board was established to inspect a firm’s SEC practice.
The AICPA will oversee the merged program, and peer reviews will be administered by an entity approved by the AICPA. For most California firms, that entity is CalCPA. Firms that perform audits of non-SEC issuers pursuant to the standards of the PCAOB, however, will have their peer reviews administered by the National
Peer Review Committee.

Firms performing audits of SEC issuers will continue to have those engagements inspected by the PCAOB. Firms subject to inspection by the PCAOB will have a peer review covering the remainder of their accounting and auditing practice that will be administered by the National Peer Review Committee.

Major Changes to the Standards
Principle-based standards. The new standards are principles-based, with the details provided in the Interpretations, allowing the Peer Review Board to be more responsive to the evolution of the peer review process. Interpretations can be amended when necessary without making changes to the actual standards.
The report review has been eliminated. There will now only be two types of peer reviews: the system review (for firms with audits) and the engagement review (for all other firms). As discussed below, the format of peer review reports has changed, and the report review format no longer fits into the new reporting concept.

The most significant change to peer review standards is the report itself, which will be written in a pass/fail format: “pass”, “pass with deficiencies” or “fail”. Users of peer review reports will now be able to determine a firm’s rating simply by reading the last sentence of the report.

How Does This Relate to System Reviews?
A report with a “pass” rating will be issued when the team captain concludes that the firm’s system of quality control over its accounting and auditing practice is suitably designed, and the firm has complied with its policies and procedures so that it has reasonable assurance of performing and reporting in conformity with applicable professional standards. A “pass” report replaces the old unmodified reports—both those with and without a letter of comment. The letter of comments has been eliminated.

A report of “pass with deficiencies” will be issued when the team captain concludes that the firm’s system of quality control over its accounting and auditing practice is suitably designed and the firm has complied with its policies and procedures so that it has reasonable assurance of performing and reporting in conformity with applicable professional standards except for a certain deficiency or deficiencies that are described in the report along with recommendations for improvement. The deficiencies identified will be conditions noted by the peer reviewer that relate to the design of, or compliance with, the firm’s quality control system and create a situation where the firm would have less than reasonable assurance of performing or reporting in conformity with professional standards. The firm will then provide a formal letter of response, indicating what it intends to do to correct the deficiencies noted in the report. A “pass with deficiencies” report replaces the old modified report.

A report with a “fail” rating will be issued when the team captain has identified significant deficiencies and concludes that the firm’s quality control system is not suitably designed or has not been complied with to provide the firm with reasonable assurance of performing and reporting in conformity with professional standards. These deficiencies and appropriate recommendations for improvement will be described in the report. The firm will then provide a formal letter of response, indicating what it intends to do to correct the deficiencies noted in the report. A “fail” report replaces the old adverse report.

How Do the New Reports Affect Engagement Reviews?
A report with a “pass” rating will be issued when the reviewer concludes that nothing came to his or her attention that caused him or her to believe that the engagements submitted for review were not performed and reported on in conformity with professional standards.

A report with a “pass with deficiencies” rating will be issued when the reviewer finds a material deficiency in one or more of the engagements submitted for review. If the same deficiency is noted in all the engagements submitted for review, a “pass with deficiency” rating is still appropriate. As in the system review, the deficiencies and appropriate recommendations for improvement will be described in the report, and the firm will be required to write a formal letter of response.

A report with a “fail” rating will be issued when material deficiencies are noted in all of the engagements submitted for review. As in the system review, the deficiencies and appropriate recommendations for improvement will be described in the report, and the firm will be required to write a formal letter of response.
The letter of comment may be gone, but “findings” still exist.

Under the current standards, when a peer reviewer answers “no” to questions on the various peer review checklists, these items are generally documented on a “Matter for Further Consideration” form because they represent departures from professional standards. These forms are then evaluated to determine whether they will be included in a letter of comment or the report itself, depending on their significance. Sometimes, such matters are resolved upon further discussion with the firm, and are discussed in the exit conference, but go no further.

Under the new standards, a “no” answer is still documented on a “Matter for Further Consideration” form, and discussed with the firm. It may be resolved then or it may be elevated into a “finding.” When the peer reviewer determines that one or more related matters result in a design problem or a compliance issue, and there is more than a remote possibility that the reviewed firm would not perform or report in conformity with professional standards, the reviewer will conclude there is a finding. Instead of placing this finding in a letter of comment, the reviewer will complete a “Finding for Further Consideration” form.
This form will be initially completed by the peer reviewer with a description of the finding and a recommendation for improvement. The firm will then respond to the finding and describe what it intends to do to correct the situation noted in the finding.

Unlike the Matter for Further Consideration, all Findings for Further Consideration will remain in the firm’s peer review file until the next peer review is completed. Because the FFC is not a part of the formal report, the tendency may be to complete these forms in a cursory fashion. Since they will remain in the peer review file, firms and peer reviewers should make certain that each FFC is complete, understandable and reflects the exact circumstances noted during the review. It is also important for firms and peer reviewers to discuss the underlying cause of findings so they may mutually agree upon an effective implementation plan.

Other Peer Review Information
The other major change to note is the transparency of peer review results. The AICPA expects to launch a secure website in 2009 where firms’ peer review reports may be accessed by state boards of accountancy that have adopted mandatory peer review. Firms may opt out of having peer review results posted on the site; for those firms, the site will only list the name of the firm and the date of its last peer review.

A state board will only have access to the peer review results of those firms with their main office in their state. However, firms may request that other state boards of accountancy be granted access to their peer review reports. Because of confidentiality issues, state boards of accountancy must request peer review results from firms instead of the peer review administering entities.

Peer review reports will remain accessible by the public for firms registered in any of the AICPA Centers: CPCAF, Employee Benefit Plan Audit Quality Center, Government Audit Quality Center and Private Companies Practice Section Firm Practice Center. Membership in these centers is voluntary.

California Law: Peer Review, Soon Playing Near You
The California Board of Accountancy has drafted proposed laws and regulations requiring mandatory peer review for all firms that perform audits, reviews, compilations and/or attest engagements. A current statute, California Business and Professions Code Sec. 5076(a), requires large firms to be peer reviewed, but implementation was delayed to allow further review by the CBA, who have decided that all firms should be subject to peer review. If passed by the Legislature, mandatory peer review would be phased in over a three-year period based on the last two digits of a firm’s license number.

While no one can predict when peer review will become mandatory in California, the fact that 41 other states have adopted some form of mandatory peer review is a strong indicator that California will follow suit. If your firm has never had a peer review, consider engaging a peer reviewer as a consultant to review a sample of accounting and auditing engagements so that necessary changes to your system of quality control or to reporting, disclosures or financial statement presentation are made now. In recent years, there have been extensive changes to professional standards applicable to accounting and auditing engagements.

CalCPA’s peer review website, www.calcpa.org/peerreview, has a directory of peer reviewers who have paid to be listed. Or ask for a recommendation from members of your CalCPA chapter; most firms have a good experience with peer review and will be happy to recommend their own reviewer.

Join the Fun: Become a Peer Reviewer
The need for peer reviewers is greater than ever. If you have experience in accounting and auditing, consider becoming a peer reviewer. In particular short supply are reviewers with governmental and ERISA experience.

“There is no doubt that my work as a peer reviewer has made me a better practitioner,” says James N. Kennedy, former chair of the California Peer Review Committee. “It requires that I stay up to date on technical issues, but it’s a lot more than that. As a peer reviewer, I have to think carefully about my own processes so I can make truly helpful suggestions to the firms I review. I think I’ve become a valued adviser to many of those firms. I also think I’ve gotten a lot more from them than I’ve been able to give.”

To find out more, visit www.calcpa.org/peerreview and click on “Become a Peer Reviewer.” Or attend “How to Conduct a Review Under the AICPA Practice-Monitoring Program,” a two-day class Oct. 27-28 sponsored by the California CPA Education Foundation in San Francisco. Search for the class by title at www.calcpa.org/RSVP

Want More?

Practice Aids

Practitioners, reviewers and users of peer review reports will want to read the standards and interpretations for more details, which may be downloaded from the AICPA’s site (www.aicpa.org/download/practmon/s009_stds.pdf).

In addition, the AICPA has issued “Navigating Through the Revised AICPA Standards for Performing and Reporting on Peer Reviews and Related Interpretations” a white paper also available online (www.aicpa.org/download/centerprp/white_paper_final_6_23_08.pdf). Exhibit A (see graphic) illustrates the flow of information under the new peer review standards.

Firms preparing for peer review in the next few months will find the AICPA’s “Guidance on Areas Where Firms are Having Recurring Deficiencies” a helpful tool (www.aicpa.org/download/members/Div?practmon/revised_deficiency_guidance_for_2008_FINAL.pdf). This paper describes many of the reporting, disclosure, presentation and documentation deficiencies noted during peer reviews, and can be a useful outline for in-house training, as well as helping firms prepare for peer review.

Peer reviewers should also consider attending a class that covers the new standards.

The AICPA is sponsoring the annual Peer Review Conference in Las Vegas Nov. 13-14, and the California CPA Education Foundation is offering the AICPA’s Advanced Course: Overview of the AICPA Peer Review Program Standards in Los Angeles Oct. 30.

For more information, visit www.calcpa.org/RSVP and enter keywords “AICPA Peer Review Program.”

 

Marcia J. Hein, CPA is a past chair of the California Peer Review Committee, technical reviewer for the California Peer Review Program and instructor on peer review for the California CPA Education Foundation. You can reach her at marcia@mjh-cpa.com.