Amendments proposed by the PCAOB would increase auditor vigilance against fraud and other noncompliance with laws and regulations. The proposal would strengthen auditors’ requirements to identify, evaluate, and communicate possible or actual noncompliance, even if the effect on the financial statements is only indirect. Comments on the proposal are due August 7 (Amendments to PCAOB Auditing Standards related to a Company’s Noncompliance with Laws and Regulations, PCAOB Release No. 2023-003, June 6, 2023).
Current PCAOB standards require the auditor to identify noncompliance with laws and regulations that have a direct and material effect on the financial statements, but they don’t say much about identifying other noncompliance that only indirectly affects the financial statements. The proposed amendments do away with this distinction between “direct” and “indirect” effects. Even so-called indirect effects like violating anti-money-laundering or environmental regulations can lead to substantial fines and penalties, ultimately harming investors, the Board reasoned.
The Board believes that improving auditing standards can both protect investors and improve audit quality: “By catching and communicating noncompliance sooner, auditors can help companies course correct and better protect investors from risk,” said PCAOB Chair Erica Y. Williams. The proposal aims to achieve this by shoring up PCAOB rules in three respects:
- Identify. The proposal would require auditors to inquire and otherwise proactively identify applicable laws and regulations that could have a material effect on the financial statements. Financial statement fraud is explicitly called out as a type of noncompliance.
- Evaluate. The amendments would strengthen requirements for evaluating whether noncompliance has occurred and, if so, the possible effects. An auditor would be required to consider if specialized skill or knowledge is needed to assist the auditor in making this evaluation.
- Communicate. The proposal would make it clear that the auditor must communicate with management and the audit committee as soon as the auditor is aware of the potential or actual noncompliance. The amendments would create a new requirement that the auditor communicate the results of the auditor’s evaluation of this information, specifically addressing which matters are likely noncompliance and the effect on the financial statements.
Affected provisions. The proposal would replace AS 2405, Illegal Acts by Clients, and retitle it A Company’s Noncompliance with Laws and Regulations. Some auditing and related professional practice standards would be amended, including AS 2110, Identifying and Assessing Risks of Material Misstatement. Finally, the amendments would rescind AS 6110, Compliance Auditing Considerations in Audits of Recipients of Governmental Financial Assistance; AI 13, Illegal Acts by Clients: Auditing Interpretations of AS 2405; and AI 21, Management Representations: Auditing Interpretations of AS 2805.
This is PCAOB Release No. 2023-003.