“Fostering Improved Financial Reporting and Transparency Through Audit Committee Communications” By: Amy Rojik, Director – National Assurance Services; BDO USA, LLP
In recent months, the Public Company Accounting Oversight Board (PCAOB) has stepped up its game with respect to encouraging more transparency about financial reporting for issuers in the form of communications between audit committees and the independent auditors.
On August 1, 2012, the PCAOB issued Release No. 2012-003, Information for Audit Committees About the PCAOB Inspection Process, to inform audit committees about its inspection process and the meaning of its inspection results.
The PCAOB explains that this release was issued to assist audit committees in (1) understanding the PCAOB’s inspections of audit firms and (2) gathering useful information from audit firms about those inspections. The goal of the release is to help audit committees in discharging their responsibility to oversee the financial reporting process. In particular, it explains that inspection reports can help inform an audit committee about how its auditor performed on specific audits and in high-risk areas across audits. In that regard, it suggests questions that the audit committee can ask the auditors to obtain that information.
The release distinguishes between Part I and Part II findings. Part I findings are made publicly available on the PCAOB’s website. They describe audit deficiencies the PCAOB found that the auditor failed to gather sufficient evidence to support an audit opinion. Part II findings are prohibited by law from being publicly released unless the audit firm fails to remediate those findings to the PCAOB’s satisfaction within 12 months of issuance of the inspection report. They describe deficiencies in the audit firm’s overall system of quality control such that the PCAOB has doubts that the system provides reasonable assurance that professional standards are met. While not prohibited by law from releasing this information, auditing firms themselves may be bound by other significant considerations such as waiving of privilege which may prevent them from further sharing such information outside of the auditing firm.
Audit committees are encouraged by the PCAOB to nonetheless understand the inspection process and engage in communications with their independent auditors about inspection findings.
On the heels of this release, on August 15, 2012, the PCAOB adopted auditing Standard No. 16 (AS 16), Communications with Audit Committees, and transitional and related amendments to other PCAOB standards. While guidance is issued for auditors, audit committees should become familiar with the standard’s requirements.
What it does: AS 16 largely retains current guidance contained in AU 380, Communication with Audit Committees, and expands and/or enhances requirements emphasizing the relevance, timeliness and quality of the communications between the auditor and the audit committee while better aligning auditing standards with the requirements of the Sarbanes-Oxley Act of 2002 (“the Act”) to facilitate audit committees’ financial reporting oversight, thus fostering improved financial reporting. AS 16 encourages effective two-way communication between the auditor and the audit committee to assist both parties in understanding matters that are relevant to the specific audit. In that sense, the standard is has been made “scalable” in an effort to avoid “boilerplate” dialogue of insignificant information.
AS 16 recognizes the audit committees’ role in protecting the interests of investors by assisting the board in fulfilling its responsibility to shareholders and others to oversee the integrity of a company’s accounting and financial reporting processes and audits. “The audit committee, among other things, serves as the [board’s] principal interface with the company’s auditors and facilitates communications between the company’s [board], its management, and its independent auditors on significant accounting issues and policies. The roles of auditors and audit committees are critical to the efficiency and integrity of the capital markets.”
What AS 16 doesn’t do: This new guidance does not impose any new performance requirements (i.e., audit procedures) on the auditor. Furthermore, it does not impose any requirements on management to communicate to the audit committee, as the PCAOB does not have the authority to do so.
Before becoming effective, AS 16 requires SEC approval, which is currently pending. Upon approval by the SEC, AS 16 will supersede the PCAOB’s interim auditing standards AU 310, Appointment of the Independent Auditor, and AU 380, and will also amend other PCAOB standards. The standard, if approved by the SEC, is expected to be effective for public company audits and audits of nonissuer brokers and dealers of fiscal periods beginning on or after December 15, 2012. Under Section 104 of the Jumpstart Our Business Startups Act (“JOBS Act”) of 2012, the standard and related amendments do NOT apply to audits of “emerging growth companies” (EGCs) unless the SEC makes such a determination under that Act that the application of such additional requirements is necessary or appropriate in the public interest. The PCAOB has indicated that it intends to request the SEC to make such a determination with regard to AS 16 and EGCs.
For further information, including an archive of the open PCAOB meeting approving AS 16, refer to the PCAOB website. The final rule may be accessed at: PCAOB Release No. 2012-004. Tune into BDO’s Ac’sense archived webinar 2012 Board Matters Quarterly Update – Q3, which explores the new standard and its requirements.
 The SEC is provided a copy of the final PCAOB inspection report. Additionally, it is PCAOB practice to transmit inspections reports to state boards where the audit firm is licensed if that board has provided written acknowledgment of its awareness of the statutory restrictions on disclosure of nonpublic portions of the report.
 AS 16 recognizes that some nonissuers, including brokers and dealers, may have governance structures that do not include boards of directors or audit committees. In those cases, the auditor would identify those persons at the nonissuer company who oversee the company's accounting and financial reporting processes and audits. This modification is meant to indicate that senior persons in an oversight role in such circumstances would be the recipients of the auditor communications. During the PCAOB’s open meeting to approve AS 16, the PCAOB staff indicated that, generally, AS 16 would apply to audits of nonissuer brokers and dealers to the extent the SEC brings those audits under PCAOB jurisdiction and further, as an example, would apply to any nonissuer that voluntarily adopts PCAOB standards (e.g., nonissuers preparing for a future IPO). Note: The SEC currently has an outstanding proposal to amend its Rule 17a-5 to essentially scope in all audits of brokers and dealers to be performed in accordance with PCAOB standards.