Wednesday, August 15, 2012

PCAOB Adopts Standard on Audit Committee Communication with Auditors, Recommends to SEC that Standard Apply to Emerging Growth Companies

The PCAOB has adopted Auditing Standard No. 16 on the independent auditor’s communications with the company’s audit committee. The standard is effective for audits conducted after December 15, 2012. The PCAOB recommended to the SEC, which must approve AS 16, that the standard be applied to emerging growth companies covered by the Jumpstart Our Business Startups (JOBS) Act. Enacted on April 5, 2012, the JOBS Act provides that any additional rules adopted by the PCAOB after April 5, 2012, do not apply to the audits of emerging growth companies unless the SEC determines that the application of such additional requirements is necessary or appropriate in the public interest, after considering the protection of investors and whether the action will promote efficiency, competition, and capital formation. The PCAOB staff, assisted by the SEC staff, has devoted substantial time and attention the question of whether AS 16 should apply to emerging growth companies. The Board has decided to make such a recommendation to the SEC.   
PCAOB Chair James Doty said that AS 16 does not embody a checklist approach and is not a check-the-box exercise, but rather promotes a meaningful exchange of information between the audit committee and the outside auditors. The PCAOB has no authority over audit committees, noted the Chair, and through this standard exercises no such authority.  But the standard appropriately describes the best auditor practices that the Board has learned from experience and advice.
Board Member Steve Harris said that AS 16 will benefit investors by enhancing the audit committee function. Indeed, investors are the ultimate beneficiaries of enhanced audit committee-auditor communication. The need for improved communication has only grown since the Sarbanes-Oxley Act was passed in 2002. Member Harris mentioned three important aspects of AS 16. First, the standard requires the auditor to communicate significant or unusual transactions to the audit committee on a timely basis and explain the business rationale for these transactions. Asked by Mr. Harris for an example of such a transaction, PCAOB Chief Auditor Marty Baumann noted that an example would be a transaction lacking economic substance, perhaps done only for accounting purposes. Second, the auditor is required to communicate to the audit committee its opinion on going concern. The Chief Auditor said that this requirement puts the audit committee into the equation as the auditor deals with going concern issues.
Third, the standard requires the auditor to tell the audit committee of the auditor’s plans to use other firms to perform required audit procedures. Member Harris said that this provision is particularly important in today’s business environment where key segments of many audits are conducted in isolated locations around the world. In addition, knowing that another firm is performing that work may lead to additional questions from the audit committee about the quality of the work performed and, possibly, whether that firm’s work has been inspected by the PCAOB.
In supporting the adoption of AS 16, Board Member Lewis Ferguson emphasized the  corporate governance aspects of the standard. He noted that increasing what the auditor communicates to the audit committee will improve the corporate governance process in general. He also observed that nothing in the standard limits the communications between auditors and audit committees. The standard sets minimum but not maximum standards for communications. If the communicated information is deemed irrelevant, he said, it can be overlooked. If audit committees want additional or more detailed information about particular topics, their members remain free to ask their auditors any questions they believe would help them understand the audit and the finances of the companies they oversee. If there are areas not included in the required communications that audit committees believe would be informative to their work, they remain free to inquire of their auditors about those matters as well.  
Board Member Jay Hanson emphasized that AU 16 should not be a checklist boilerplate exercise. No one wanted that. It is about effective and timely communication about items important to the audit and to the financial statements. AS 16 builds on what auditors are already doing, he said, and will help audit committees to do their best work. Member Hanson specifically mentioned that he supports the recommendation to the SEC that AS 16 be applied to emerging growth companies. He also noted that the Board has much work to do to assess the economic consequences of other pending standard-setting projects to support making similar recommendations on those projects, when appropriate.  The Board is also facing the significant task of evaluating how to incorporate more robust economic analysis in its standard-setting process more generally, including how to begin with a clear articulation of each problem, how to prioritize the problem, and how to assess possible solutions.
Board Member Jeanette Franzel also emphasized the essential role that the audit committee plays in corporate governance. The Board supports the audit committee’s important oversight role by focusing on significant issues that should be discussed with the auditor. She noted that Auditing Standard No. 16 is based on the practical, common sense approach of leveraging the work already performed during an audit and targeting the communications to cover areas that are significant to the financial reporting process. The standard does not impose new auditor performance requirements, other than the required communications themselves. Member Franzel also specifically supported the recommendation that the SEC allow AS 16 to be applied to emerging growth companies.