PCAOB Revamps Audit Committee Communication Proposals
The Public Company Accounting Oversight Board voted Tuesday to re-propose for public comment its proposed standards for how auditors should communicate with audit committees.
The standards have been in the works for nearly two years. Like the original proposal, the re-proposed standard would establish requirements to enhance the relevance and quality of communications between an auditor and the audit committee.
However, the latest version also takes into account the fact that the Dodd-Frank Act gives the PCAOB authority over auditors of broker-dealers, and gives commentators an opportunity to submit feedback on the implications of that change. The re-proposed standard would also better align the communication requirements with performance requirements in other PCAOB standards, including the implementation of the risk assessment standards in Auditing Standard Nos. 8-15 that took effect last December. The latest proposals also include changes made in response to comments received on the original proposal and other refinements.
"Communication with audit committees is a fundamental responsibility of any auditor and has a direct and serious impact on the quality of that audit,” said PCAOB Chairman James R. Doty in a statement. “This reproposal is intended to further enhance those communications.”
He pointed out that the latest proposals are designed to move auditors away fr om simple compliance checklists and into more meaningful, effective interchange. “In particular, what investors have found disquieting about the lessons learned in the financial crisis is that audit committees and boards may have lacked the information necessary to assess whether better financial reporting and disclosure would have been appropriate,” he noted. “It is not necessarily a question of access to information, or volume, but of relevance and quality. One of the reasons that investors think that the audit committee is so important is that it is in a position to influence better financial reporting by demanding better practices, more responsible business judgment and improved conduct fr om management. But to do so, the audit committee must be well-informed about the salient facts and issues relating to accounting and disclosure matters. An audit committee that is well-informed is in a better position to make sure that such matters are resolved in the best interest of investors.”
PCAOB board member Daniel Goelzer pointed out that the new proposals take into account the board’s expanded authority under the Dodd-Frank Act over auditors of broker-dealers. “Because of the diversity in the size and form of organization of the roughly 5,000 registered broker-dealers, I think it is important that we invite comment that focuses specifically on how the new standard would function in that industry,” he said. “Many broker-dealers are small, closely-held companies that do not have an audit committee, or even an independent board of directors. We need to make sure that these communications requirements will be workable in that environment.”
Goelzer noted that there had been other changes since the original proposals were exposed. One of the center-pieces of the original proposal—the requirement that auditors evaluate the two-way communications process between the auditor and the audit committee—has been deleted. In addition, the requirements concerning auditor communications regarding management’s critical accounting estimates have been streamlined.
“Perhaps most importantly, a new requirement that the auditor communicate with the audit committee regarding significant transactions not in the ordinary course of business has been added,” Goelzer noted. “Before the standard is finalized, the board should give investors, preparers, and auditors the opportunity to consider these changes and to let the board know what they think the impact will be.”
Another PCAOB board member, Jay Hanson, noted that the standard is aimed at avoiding the information overload and excessive costs that could result if auditors are required to communicate too much information that is not relevant to the audit committee’s monitoring and oversight role. However, he pointed out that nothing would prevent audit committees from requesting more information from auditors if deemed appropriate in light of the relevant circumstances.
“Likewise, nothing prevents auditors from volunteering information above and beyond that required by today’s proposed standard,” said Hanson. He added that while some commenters had asked the PCAOB to require auditors to discuss their assessment of the company’s “tone at the top,” the board was careful to tie its communications requirements in the proposed standard to existing requirements for audit procedures in order to avoid increasing the substantive audit work that must be performed through the communication standard.
As a result, the proposed standard addresses the “tone at the top” issue only insofar as AS 5 includes audit performance requirements to evaluate management in connection with the control environment, he noted. “Audit committees are free, however, to expand on these discussions with their auditors by asking for additional information about management’s philosophies and priorities, in order to develop a more comprehensive picture of the company’s tone at the top,” said Hanson,
Some commenters also suggested that the PCAOB retain the originally proposed requirement that auditors discuss with the audit committee the quality, clarity and completeness of the company’s financial statements and related disclosures. However, the latest version of the standard omits this requirement, Hanson noted, stating only that the auditor must communicate the results of the auditor’s evaluation of whether the presentation of the financial statement and related disclosures are in conformity with the applicable financial reporting framework. “Nevertheless, the standard does not prevent auditors from communicating, or audit committees from asking their auditors to communicate, the auditor’s view about the quality, clarity and completeness of the financial statements and disclosures,” said Hanson. “Doing so may be particularly appropriate in connection with the audits of companies with complex financial transactions or investments and significant use of fair value measurements and management estimates.”
The proposed standard also does not impose a specific timeline for the various communications, he noted. “Recognizing that audits vary in complexity and duration, it requires only that the communications be made in a timely manner and before issuance of the audit report, and it notes that the appropriate timing of communications may depend on the significance of the matter to be communicated and the necessary follow-up actions required,” said Hanson. “However, audit committees always have the discretion to request auditor communications in connection with certain specific audit milestones wh ere appropriate. They also may want to reinforce the standard’s objective by encouraging auditors to communicate important matters early enough during the audit to allow sufficient time for such matters to be considered fully by the audit committee and for any necessary consultation or supplemental audit procedures.”
PCAOB board member Steven Harris pointed to two of the most important communications within the proposal: communication of significant unusual transactions of which the auditor becomes aware and communication of the auditor’s views on the ability of an issuer to continue as a going concern.
“The requirement that the auditor communicate to the audit committee any significant transactions outside the normal course of business for the company—including any transactions that appear to be unusual due to their timing, size, or nature—is new in this re-proposal,” said Harris. “The auditor also would be required to explain his or her understanding of the business rationale for such transactions. In addition, this proposal includes a requirement for the auditor to communicate any conditions that indicate there could be substantial doubt about the company’s ability to continue as a going concern. Furthermore, if the auditor’s doubt about the company’s ability to continue as a going concern is allayed, the proposal requires the auditor to communicate why the auditor is no longer concerned, including a discussion of management’s plans to mitigate those concerns.”
Another board member, Lewis Ferguson, questioned whether the new standard might still lead to a compliance checklist approach. “One question is whether specifying particular items that must be discussed with the audit committee runs the risk of leading to ‘checklist’ compliance wh ere items are ticked off but not made the subject of substantive and thoughtful discussion,” he said. “There are two answers to this concern. Evidence in other areas (checklists used in medicine, particularly surgical procedures, or pre-flight checklists in aviation) have shown definitively that checklists can actually reduce the risk of error in complex tasks and specifying the items that must be discussed with the audit committee in the context of an audit may have a similar, salutary effect. In addition, the proposed standard specifically warns against perfunctory compliance and encourages auditors to have a robust dialogue with the audit committee.”
The proposed auditing standard would supersede PCAOB interim standard AU sec. 380, Communication With Audit Committees, and AU sec. 310, Appointment of the Independent Auditor, and amend other PCAOB standards. Any new auditing standard and amendments to other PCAOB standards adopted by the PCAOB will be submitted to the Securities and Exchange Commission for approval.
Comments on the reproposed standard are due Feb. 29, 2012. The PCAOB said it would carefully consider all comments received before taking final action on the reproposed standard. The proposing release, the reproposed auditing standard, and related amendments to PCAOB standards and comment letters will be available on the website under Rulemaking Docket No. 030. An archive of the webcast and a podcast of the Open Board Meeting also will be available on the PCAOB Web site at www.pcaobus.org.