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.

[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

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).
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    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.
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    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.

    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.
---------------------------------------------------------------------------

    \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

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.
---------------------------------------------------------------------------

    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

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.
---------------------------------------------------------------------------

    \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.
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    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\
---------------------------------------------------------------------------

    \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

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.
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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.
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    \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.
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    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\
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    \106\ See AS 1201.C6, as adopted.
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    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.
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     The specialist's findings and conclusions are inconsistent
with (1) the results of the work performed by the specialist, (2) other
evidence obtained

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).
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    \108\ See AS 2101.17.
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    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.

    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.
---------------------------------------------------------------------------

    \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

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

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.
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    \117\ See AS 1015.07.
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    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
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    \118\ See note to AS 1210.12, as amended.
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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.
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    \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.
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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

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.

---------------------------------------------------------------------------

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

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

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,

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.
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    \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).
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    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.
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    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

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\
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    \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.
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    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.
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    \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.
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    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