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.