On August 15, 2012, the Public Company Accounting Oversight Board (PCAOB) announced its adoption of new Auditing Standard No. 16 – “Communications with Audit Committees.” This standard establishes requirements for specific types of communications by an auditor with a client’s audit committee prior to issuance of the auditor’s report. Many of these communications likely have been conducted by auditors previously, but some may require new audit committee procedures. The PCAOB has stated that the purpose of the new requirements is to encourage effective two-way communication between the auditor and the audit committee. The PCAOB anticipates that the requirements, subject to SEC approval, will be effective for audits of fiscal years beginning on or after December 15, 2012.

Under the auditing standard, the auditor is required to determine that the audit committee has acknowledged and agreed to the terms of the auditor’s engagement. The standard provides that if the engagement letter is signed on behalf of the company by parties other than the audit committee, or its chair on behalf of the audit committee, the auditor is required to determine that the audit committee has acknowledged and agreed to the terms of the engagement. Presumably, auditors may require that this acknowledgment and agreement be in writing.

While the standard retains preexisting communication requirements imposed by auditing standards and the SEC, the standard expands existing requirements by requiring the auditor to communicate:

  • Certain matters regarding the company’s accounting policies, practices and estimates
  • The auditor’s evaluation of the quality of the company’s financial reporting
  • Information related to significant unusual transactions, including the business rationale for such transactions
  • The auditor’s views regarding significant accounting or auditing matters when the auditor is aware that management consulted with other accountants about such matters, and the auditor has identified a concern regarding these matters

Also, the standard adds new requirements for the auditor to provide the audit committee with additional information about significant aspects of the audit. These include the following:

  • An overview of the overall audit strategy, particularly the timing of the audit, significant risks the auditor identified, and significant changes to the planned audit strategy or identified risks
  • Information about the nature and extent of specialized skill or knowledge needed in the audit; the extent of the planned use of internal auditors, company personnel or other third parties; and other independent public accounting firms, or other persons not employed by the auditor who are involved in the audit
  • The basis for the auditor’s determination that he or she can serve as principal auditor, if significant parts of the audit will be performed by other auditors
  • Situations in which the auditor identified a concern regarding management’s anticipated application of accounting pronouncements that have been issued but are not yet effective, and might have a significant effect on future financial reporting
  • Difficult or contentious matters for which the auditor consulted outside the engagement team
  • The auditor’s evaluation of going concern
  • Departure from the auditor’s standard report
  • Other matters arising from the audit that are significant to the oversight of the company’s financial reporting process, including complaints or concerns regarding accounting or auditing matters that have come to the auditor’s attention during the audit

The new auditing standard expands upon existing Auditing Standard No. 12 – “Identifying and Assessing Risks of Material Misstatement,” which currently requires the auditor to inquire of the audit committee regarding matters important to the identification and assessment of risks of material misstatement and fraud. The additional inquiry by the auditor mandated in Auditing Standard No. 16 asks whether the audit committee is aware of “matters relevant to the audit,” including, but not limited to, violations or possible violations of laws or regulations. Audit committees may wish to consider what procedures if any should be adopted in order to respond to an inquiry of this type.

The standard specifies that required communications by the auditor to the audit committee should be made in a timely manner, taking into account the significance of the matters involved, and the corrective or follow-up action needed. Communications may be made to only the audit committee chair if done in order to communicate matters in a timely manner during the audit. However, such matters are to communicated to the full committee prior to the issuance of the auditor’s report. Communications may be oral or written. The auditor must document the communications in the work papers, whether the communications were oral or written.