PCAOB Reissues Proposal to Enhance Communications between Auditors and Audit Committees
Susan M. Greenwood | Bloomberg Law
- New standards will apply to audits of brokers and dealers.
- Auditors will communicate on topics ranging from issues arising during their retention to whether the company can continue as a going concern.
The Public Company Accounting Oversight Board (PCAOB) announced that it was reproposing for comment an auditing standard on Communications with Audit Committees. The standard first was proposed in March 2010. For more on the original proposal, see Bloomberg Law Reports®—Securities Law, PCAOB Proposes Auditing Standard Concerning Communications with Audit Committees (Apr. 1, 2010).
Rethinking Audit Committee Communications
According to the PCAOB, certain developments in PCAOB oversight and standards necessitate the new proposal (Proposal). First, in August 2010, the PCAOB adopted new “risk assessment standards” for auditor performance requirements. The Proposal aligns the risk assessment standards with the audit committee communication requirements. Next, the Dodd-Frank Wall Street Reform and Consumer Protection Act grants the PCAOB oversight of audits of broker and dealers that are registered with the Securities and Exchange Commission (SEC). The Proposal provides brokers and dealers with the opportunity to submit comments to the PCAOB. Moreover, the PCAOB drafted the Proposal with the benefit of comments received on the original proposal.
Discussing the Proposal, PCAOB Chairman James Doty noted that comments to the original proposal stressed that “the enhanced role of the audit committee is one of the most important reforms advanced by the Sarbanes-Oxley Act.” Accordingly, the Proposal seeks to further strengthen “the effectiveness of the audit committee” by improving the “relevance and quality” of information that passes between a company’s outside auditor and the audit committee. Comments on the Proposal are due February 29, 2012.
Changes to Original Proposal
The Proposal modified the objectives of the new standard to emphasize the importance of information that an auditor receives from the audit committee. Accordingly, the new objectives focus on the auditor’s ability to (1) “communicate to the audit committee the responsibilities of the auditor in relation to the audit and establish an understanding of the terms of the audit engagement with the audit committee,” (2) obtain information from the audit committee relevant to the audit,” (3) “communicate to the audit committee an overview of the overall audit strategy and timing of the audit,” and (4) “provide the audit committee with timely observations arising from the audit that are significant to the financial reporting process.”
— Highlighting the Most Important Information
While many provisions of the Proposal mirror the original, the PCAOB did change and clarify many sections in order to focus the auditor and audit committee on the most relevant and important information concerning an audit. For example, in discussing its appointment or retention with the audit committee, the auditor should communicate any “significant issues” concerning its retention that were discussed with management. This includes “significant discussions” of the application of accounting principles or auditing standards, rather than “any discussions” involving accounting or auditing issues, which the original proposal required. Similarly, PCAOB modified the Proposal to specify that the auditor “should inquire of the audit committee about matters that might be relevant to the audit, including, but not limited to, knowledge of violations or possible violations of laws or regulations and complaints or concerns raised regarding financial reporting matters.” The change, the PCAOB said, was to clarify that information sought from the audit committee should not be limited to “complaints or concerns raised regarding accounting or auditing matters.”
— Dealings with Management
The Proposal further altered how an auditor participates in discussions with the audit committee. While past PCAOB standards only required the auditor to keep the audit committee “informed,” the Proposal compels the communication of “significant accounting principles.” However, the PCAOB was mindful to avoid requiring the auditor to duplicate information provided by management. Therefore, it removed from the Proposal a requirement that the auditor inform the board about management’s monitoring of critical accounting estimates. In the same way, the Proposal allows an auditor to met its obligation to discuss “accounting policies, practices, and estimates” with the audit committee if the auditor (1) participates in management’s discussion of these issues, (2) “affirmatively confirms” that management’s discussion is adequate, and (3) identifies the accounting policies and practices it considers “critical.”
Other changes to the original proposal seek to provide the audit committee with additional information concerning oversight of the financial reporting process. Under the Proposal, the audit committee must be informed of “difficult or contentious matters” on which it (1) sought consultation from outside the engagement team and (2) determined are relevant to the audit committee’s oversight of the financial reporting process. Further, the Proposal requires the auditor to inform the audit committee about its “concern[s] regarding management’s anticipated application of accounting pronouncements that have bee issued but are not yet effective and might have a significant effect on future financial reporting.”
— Expanding Information Provided to Audit Committees
Certain pieces of information that the auditor must provide to the audit committee will allow the committee to evaluate both the audit process and its impact on the company’s continuing operations. For example, under the Proposal, the auditor must provide “the names, locations, planned roles, and responsibilities, including the scope of audit procedures, of other independent public accounting firms or other persons, who are not employed by the auditor, that perform audit procedures in the current period.” In addition to naming the auditors performing the audit, the Proposal requires the auditor to share its “evaluation of whether the presentation of the financial statements and related disclosures are in conformity with the applicable financial reporting framework” as well as its “assessment of management’s disclosures relating to critical accounting policies and practices.”
Importantly, the Proposal calls for the auditor to inform the audit committee of “significant transactions that are outside the normal course of business for the company,” including the auditor’s “understanding of the business rationale for such transactions.” According to the PCAOB, this requirement will allow the audit committee to hear the auditor’s “perspective of management’s intentions regarding such transactions.” Further, the Proposal provides an “early warning system” for the audit committee by requiring the auditor to report, under certain circumstances, a company’s “ability to continue as a going concern.”
Thoughts from the PCAOB Board
In addition to Chairman Doty, the four additional PCAOB board members support the Proposal and its focus on improving the quality of information passed from the auditor to the audit committee. According to Lewis Ferguson, the Proposal will “insure that at least the audit committee, made up solely of independent directors, will be made aware of the nature of the auditor’s work, the risk areas identified, the complex financial accounting issues addressed during the audit, and other factors that should give a good window into the auditor’s thinking and experience in the course of the audit.” Daniel Goelzer agreed, noting that the Proposal will further the “objective of the Sarbanes-Oxley Act . . . to put the audit committee, rather than management, in the driver’s seat of the relationship between a public company and its auditor.”
Additionally, Jay Hanson explained that while the Proposal strives to “better enable audit committees to perform their oversight responsibilities,” it does prevent either the audit committee from requesting or the auditor from voluntarily providing additional information. Indeed, Steven Harris commented that “communication between an auditor and the audit committee is a two-way street.” He also noted that PCAOB will continue to address communications between audit committees and auditors, particularly as to PCAOB inspections.
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