Public Company Accounting Oversight Board (PCAOB) Standard 16 ("AS 16"), establishes new requirements on communications with Audit Committees and related amendments to PCAOB standards.1
The new standard is intended to enhance the relevance, timeliness, and quality of the communications between the auditor and the Audit Committee relative to the annual audit and related interim period reviews, and foster constructive dialogue between the auditor and the Audit Committee about significant audit and financial statement matters. The new standard, which was approved by the SEC on December 17, 2012, supersedes the PCAOB’s existing interim standards on communications with Audit Committees and appointment of the independent auditor.
The new standard includes four objectives for the auditor’s communications with the Audit Committee:
- Communicate the auditor’s responsibilities and establish an understanding of the terms of the audit engagement with the Audit Committee (Enhanced);
- Obtain information from the Audit Committee that is relevant to the audit (Enhanced);
- Communicate an overview of the overall audit strategy and timing (New); and
- Provide timely observations arising from the audit that are significant to the financial reporting process (Enhanced).
It should be noted that the AS 16 maintains the option that the communication between the auditor and Audit Committee can take the form of either oral or written communication, unless otherwise specified in the standards, but that the auditor must document the communication in its files, irrespective of the method.
Communication of Auditor’s Responsibilities and Terms of Audit Engagement
Similar to the existing requirement, AS 16 has enhanced the direct communication with the Audit Committee relating to establishing an understanding of the terms of the audit:
- The auditor is required to discuss with the Audit Committee any significant issues that were discussed with management in connection with the initial appointment or retention of the auditor, including any significant discussions about applying accounting principles and auditing standards, and
- Establish an understanding of the terms of the audit engagement with the Audit Committee, which includes communicating the objective of the audit, the responsibilities of the auditor and the responsibilities of management in an engagement letter. The engagement letter should be provided to the Audit Committee annually. If a party, other than the Audit Committee or its chair, executes the engagement letter on behalf of the Audit Committee, the auditor should determine that the Audit Committee has acknowledged and agreed to the terms of the engagement.
Obtaining information from the Audit Committee that is relevant to the audit
The new standard requires the auditor to inquire if the Audit Committee is aware of matters that may be relevant to the audit, including, but not limited to, violations or possible violations of laws or regulations.
Communication of the overview of the overall audit strategy and timing
Additional communication requirements to the Audit Committee include an overview of the overall audit strategy, including, but not limited to:
- the timing of the audit,
- a discussion of the significant risks identified by
the auditor during its risk assessment procedures, and, if applicable,
- the need for specialized skills to perform the audit,
- the extent to which the auditor plans to use the work of the company’s internal audit function, the extent to which the auditor plans to use company personnel (in addition to internal auditors) or third-parties working under the direction of management or the Audit Committee when performing an audit of internal control over financial reporting,
- the names, locations, and planned responsibilities of other independent public accounting firms (including network affiliated member firms) or other persons, who are not employed by the auditor, that perform audit procedures in the current audit period, and
- the basis for the auditor’s determination that it can serve as principal auditor, if significant parts of the audit are to be performed by other auditors.
Observations arising from the audit that are significant to the financial reporting process
Auditing Standard No. 16 continues and enhances the existing standards and the SEC communication’s requirements, but includes additional communication requirements in an effort to provide strong linkages to other PCAOB auditing standard performance requirements. Many of the new standards are intended to promote the auditor’s active participation in communicating the significant accounting policies and practices rather than just determining that the Audit Committee was informed on matters including, but not limited to:
- Significant accounting policies and practices,
- Critical accounting policies and practices,
- Critical accounting estimates,
- Significant unusual transactions,
- Quality of financial statement presentation,
- New accounting pronouncements, and
- Alternative accounting treatments.
The new standard expands existing requirements for the auditor to communicate other matters arising from the audit that are significant to the oversight of the financial reporting process. This communication includes, among other matters, complaints or concerns regarding accounting or auditing matters that have come to the auditor’s attention and the results of the auditor’s procedures regarding such matters.
Several other communications are linked to the results of audit procedures or the conduct of the audit that should be addressed with the Audit Committee and include:
- Auditor’s evaluation of the company’s ability to continue as a going concern (if substantial doubt exists, then a presentation of the basis of the auditor’s conclusion and the impacts of the conclusion, whether alleviated or not)
- Provision of a schedule of uncorrected misstatements presented to management, aligning with the SEC rules
- Difficult or contentious matters for which the Auditor consulted outside services
- Auditor’s assessment of significant audit or accounting matters where management consulted with other accountants, if the auditor has concerns regarding such consultations
- Material written communications between the auditor and management (incorporates the existing SEC requirement)
- Departure from the Auditor’s Standard Report (reasons for the modification and the wording of the report changes)
- Disagreements with management, whether satisfactorily resolved or not (disagreements with management do not include differences of opinion based on incomplete facts or preliminary information that are later resolved by the auditor obtaining additional relevant facts or information)
- Difficulties encountered in performing the audit (additional examples of matters that might constitute significant difficulties provided)
The adoption of the new standard resulted in amendments to AU Section 722, Interim Financial Information, which impacts the auditor’s communication with the Audit Committee. The amendments to the interim standard include the same communication requirements as would be necessary during year end procedures.
Timing of Communications
All Audit Committee communications required by the new standard should be made in a timely manner and prior to the issuance of the auditor’s report. Any communications related to interim reviews should be made prior to the company filing its periodic report with the SEC.
The auditor may communicate to only the Audit Committee chair if done in order to communicate matters in a timely manner during the audit. The auditor, however, should communicate such matters to the Audit Committee prior to the issuance of the auditor’s report.
The new standard and related amendments are effective for audits and interim reviews of fiscal years beginning on or after December 15, 2012.
In the situation where the SEC’s amended rules have an effective date earlier than the effective date of the new standard, audits of brokers and dealers subject to PCAOB requirements would need to comply with the transitional amendments to AU Section 380 prior to the effective date of the new standard.
The SEC has also approved the PCAOB’s request to apply AS 16 to the audits of Emerging Growth Companies.
Not only do the changes under AS 16 increase the requirements of the auditor to communicate important audit and accounting matters to the Audit Committee that may not otherwise have been previously discussed, the new standard sets forth a road map for Audit Committees to increase their oversight on behalf of their respective companies. The two-way communication throughout the audit process is meant to facilitate an improved understanding of the financial health and management’s position on critical matters – important and necessary tools for any Audit Committee member.
Center for Audit Quality, Oct 24, 2012,“CAQ Webcast – Communications with Audit Committees: Requirements and Leading Practices”.
1 . PCAOB, Auditing Standard No. 16, Communications with Audit Committees and Related Amendments to PCAOB Standards; and Transitional Amendments to AU Section 380, available at: http://pcaobus.org/Rules/Rulemaking/Docket030/Release_2012-004.pdf