PCAOB Standards-Setting Update¹
By Gary L. Holstrum* and Douglas R. Carmichael**
Prior PCAOB update articles in the Spring 2005 and Summer 2005 issues of The Auditor's Report contain background information about the PCAOB standards-setting process and initial work to develop research syntheses related to two PCAOB projects. In addition, those articles include hyperlinks to PCAOB briefing papers on a variety of its standards-setting projects.
This update focuses on PCAOB standards-setting developments that have occurred since the last PCAOB update in the Summer 2005 issue, including –
- Additional staff guidance on audits of internal control;
- New rules on independence, tax services, and contingent fees and a new standard on Reporting on Whether a Previously Reported Material Weakness Continues to Exist; and
- The 2006 PCAOB proposed standards-setting projects and information about the formation of research teams by the Auditing Section to develop syntheses of existing research related to each major project.
Additional Staff Guidance on Audits of Internal Control — To assist in the implementation of audits of internal control, the PCAOB, on May 16, issued 18 Staff Guidance Q&As accompanied by a Board Policy Statement expressing the Board's view that, to properly plan and perform an effective audit under Auditing Standard No. 2, auditors should –
- • Integrate their audits of internal control with their audits of the client's financial statements, so that evidence gathered and tests conducted in the context of either audit contribute to completion of both audits;
- • Exercise judgment to tailor their audit plans to the risks facing individual audit clients, instead of using standardized "checklists" that may not reflect an allocation of audit work weighted toward high-risk areas and weighted against unnecessary audit focus in low-risk areas;
- • Use a top-down approach that begins with company-level controls, to identify for further testing only those accounts and processes that are, in fact, relevant to internal control over financial reporting;
- • Use the risk assessment required by the standard to eliminate from further consideration those accounts that have only a remote likelihood of containing a material misstatement;
- • Take advantage of the significant flexibility that the standard allows to use the work of others; and
- • Engage in direct and timely communication with audit clients when those clients seek auditors' views on accounting or internal control issues before those clients make their own decisions on such issues, implement internal control processes under consideration, or finalize financial reports.
The PCAOB also devoted the June 2005 meeting of its Standing Advisory Group to a discussion of implementation issues related to the first year of audits of internal control and appropriate strategies for the second year of audits.
Independence, Tax Services, and Contingent Fees — On July 26, following public comment on proposed rules, the PCAOB adopted, subject to SEC approval, ethics and independence rules that focus on independence, tax services, and contingent fees. The rules treat a registered firm as not independent of a public company audit client if the firm, or an affiliate of the firm, provided any service or product to an audit client for a contingent fee or a commission, or received from an audit client, directly or indirectly, a contingent fee or commission. The rules also treat such a firm as not independent if the firm, or an affiliate of the firm, provided assistance in planning, or provided tax advice on, certain types of potentially abusive tax transactions to an audit client or provided any tax services to certain persons employed by an audit client. Further, the rules require registered public accounting firms to provide certain information to audit committees in connection with seeking pre-approval to provide non-prohibited tax services. The rules also establish that a person associated with a registered public accounting firm shall not cause that firm to violate the Sarbanes-Oxley Act, the Rules of the Board, relevant provisions of securities laws and rules, and professional standards due to an act or omission the person knew, or was reckless in not knowing, would directly and substantially contribute to such violation.
Proposal of a Standard on Reporting on Whether a Previously Reported Material Weakness Continues to Exist —Following public comment on a proposed standard, the PCAOB, on July 26, adopted an auditing standard, subject to SEC approval, that establishes requirements and provides direction for an auditor who is engaged to report on whether a previously reported material weakness in internal control over financial reporting continues to exist as of a date specified by management. The engagement described by this standard is voluntary. The standards of the PCAOB do not require an auditor to undertake an engagement to report on whether a previously reported material weakness continues to exist. The auditor may audit the company's internal control over financial reporting in accordance with Auditing Standard No. 2 without ever performing an engagement in accordance with this standard.
Proposed 2006 Standards-Setting Projects and Auditing Section Research Synthesis Teams — Auditing Section leaders have had an excellent response to their web site call for participants in a research program related to PCAOB standards-setting projects. Section leaders are in the process of forming teams of researchers to develop syntheses of research related to each major proposed 2006 PCAOB standards-setting project, and they expect to announce the teams in early November. The major proposed 2006 PCAOB standards-setting projects are shown below, with hyperlinks to related PCAOB staff briefing papers on the PCAOB Web site:
Additional information about some of these projects is available in hyperlinked materials for the October meeting of the PCAOB Standing Advisory Group, which included discussion of the 2006 proposed standards-setting projects, panel sessions on engagement quality reviews in smaller firms and communications with audits committees, reasonable assurance, and principles of audit reporting.
¹Note the hyperlinks to the PCAOB Web site (www.pcaobus.org) and to the announcement of the research synthesis program on the Auditing Section Web site.
*Gary Holstrum is Associate Chief Auditor and Director of Research at the PCAOB.
**Douglas Carmichael is PCAOB Chief Auditor and Director of Professional Standards.
The views expressed in this article are those of the authors and not necessarily those of the Board, individual Board members, or other PCAOB staff. Responses to the article or related research may be emailed to firstname.lastname@example.org.