PCAOB Standards-Setting Update
Prepared for The Auditor's Report (Summer 2006)
By Gary Holstrum* and Thomas Ray**
This update addresses selected PCAOB developments since the Spring 2006 update. These include an overview of the PCAOB/SEC Roundtable on internal control, the PCAOB statement regarding 2006 inspections, recent PCAOB standards and rules approved by the SEC, and a PCAOB Symposium on the Auditing Section's Research Synthesis Program.
PCAOB and SEC Roundtable on Internal Control Reporting Requirements. On May 10, 2006, the PCAOB and Securities Exchange Commission (“SEC”) sponsored a roundtable to discuss second-year experiences with the internal control reporting requirements under the Sarbanes-Oxley Act of 2002. At the roundtable, representatives of public companies, auditors, investors, and others participated in five panels to discuss their experiences with the Act's Section 404 requirements. In addition to establishing the roundtable panels, the PCAOB and SEC also issued an open invitation for written comments regarding 404 experiences. Feedback related to the roundtable will allow the SEC and PCAOB to further assess the implementation of the 404 requirements and continue to develop policies that improve the accuracy and reliability of financial reporting for the benefit of investors in a way that is both efficient and effective. Both the PCAOB Web site (www.pcaobus.org) and SEC Web site (www.sec.gov) provide information about the roundtable, including a webcast of the roundtable panel discussions as well as roundtable comment letters, a roundtable briefing paper, and selected other materials that should be very helpful to researchers, educators, students, practicing auditors, and others.
Board Issues Statement Regarding 2006 Inspections. On May 1, the Board released a statement regarding its approach to inspections of the firms' audits of internal control over financial reporting ("ICFR"). The statement indicates that the 2006 inspections will place emphasis on the efficiency of the firms' performance of audits of ICFR in an effort to improve the cost-effectiveness of these audits. The 2006 inspections will, in part, examine how well the firms implemented the Board's guidance of May 16, 2005, and its November 30, 2005, report on the initial implementation of PCAOB Auditing Standard No. 2. The May 1 statement indicates that inspectors will evaluate:
- the degree to which the audit of ICFR and the audit of financial statements were performed as a single, integrated, and mutually reinforcing process;
- whether auditors use a top-down approach in which company-level controls were identified as the first step in planning the audit;
- whether auditors properly assessed risk and used a risk-based approach to determine the nature, timing, and extent of internal control testing; and
- whether auditors took full advantage of the opportunities available to use the work of others, such as the company's internal audit staff.
SEC Approves PCAOB Rules on Auditor Ethics, Independence and Tax Services. In April 2006, the SEC approved PCAOB ethics and independence rules, adopted by the PCAOB in July 2005, concerning independence, tax services, and contingent fees. The rules have varying effective dates and accomplish the following:
- Rule 3502 codifies the principle that persons associated with a registered public accounting firm (e.g., individual accountants) can be held responsible when certain of their actions contribute to a firm's violation of relevant laws, rules, or professional standards.
- Rule 3520 introduces a foundation for the independence component of the Board's ethics rules by establishing a general obligation requiring a registered public accounting firm and its associated persons to be independent of the firm's audit clients throughout the audit and professional engagement period.
- Rule 3521 treats registered public accounting firms as not independent of their audit clients if they enter into contingent fee arrangements with those clients.
- Rule 3522 identifies circumstances in which the provision of tax services impairs an auditor's independence, including services related to marketing, planning, or opining in favor of the tax treatment of, among other things, transactions that are based on aggressive interpretations of applicable tax laws and regulations.
- Rule 3523 treats a registered public accounting firm as not independent if the firm provides tax services to certain members of management who serve in financial reporting oversight roles at an audit client or to immediate family members of such persons.
- Rule 3524 further implements the Sarbanes-Oxley Act's requirement that auditors' non-audit services be pre-approved by the audit committee by strengthening the auditor's responsibilities in connection with seeking audit committee pre-approval of tax services.
SEC Approves PCAOB Auditing Standard on Reporting on the Elimination of a Material Weakness. In February 2006, the SEC approved PCAOB Auditing Standard No. 4, adopted by the Board in July 2005, which applies when auditors report on whether a previously reported material weakness in a company's ICFR continues to exist as of a date specified by management. When an issuer reports a material weakness in ICFR, management may, prior to the next annual report, voluntarily decide to seek auditor agreement that the material weakness no longer exists. AS No. 4 describes the auditor's responsibilities in obtaining reasonable assurance and reporting on whether the previously reported material weakness continues to exist. However, an AS No. 4 report is neither an opinion nor an update of a previous opinion on the overall effectiveness of ICFR. Rather, the report pertains only to whether the material weakness identified in the report continues to exist as of the date of management's assertion. The SEC's order approving the auditing standard is available on the SEC's Web site. The text of AS No. 4 can be found under Rulemaking on the Board's Web site.
PCAOB Symposium on the Research Synthesis Program. On February 16- 17, 2006, the PCAOB hosted a symposium focusing on the work of nine teams of academic researchers organized by the Auditing Section of the American Accounting Association. As reported in previous issues of The Auditor's Report, the academic research teams are developing reports synthesizing existing research relevant to these nine key 2006 PCAOB standards projects:
Approximately 70 people participated in the symposium, including 40 academic researchers who were either members of the research synthesis teams, officers in the Auditing Section or the AAA, or editors of leading academic journals. In addition, PCAOB staff responsible for the standards-setting process and representatives from the Securities and Exchange Commission, the Financial Accounting Standards Board, and the Government Accountability Office also participated.
Note the hyperlinks to the PCAOB Web site (www.pcaobus.org) and to the Auditing Section Web site. A convenient history of PCAOB standards-setting activity and related briefing papers are available through the hyperlinked previous PCAOB Standards-Setting Update articles in the Spring 2005, Summer 2005, Fall 2005, Spring 2006 issues of The Auditor's Report.
*Gary Holstrum is PCAOB Associate Chief Auditor and Director of Research.
**Thomas Ray 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.