On August 15, the Public Company Accounting Oversight Board (PCAOB) adopted Auditing Standard No. 16, Communications with Audit Committees, specifying requirements that will govern a registered auditor’s communications with the audit committee of a public company. The new standard replaces and expands the PCAOB’s interim auditing standards AU sec. 310, Appointment of the Independent Auditor, and AU sec. 380, Communication With Audit Committees. The PCAOB issued Auditing Standard No. 16 to foster a more timely and relevant exchange of information between the auditor and the audit committee during the audit process on matters that may affect the integrity of the company’s financial statements.

Auditing Standard No. 16 will become effective upon approval by the SEC, which is expected to occur, so that the new standard will be effective for public company audits of fiscal periods beginning on or after December 15, 2012. The SEC separately must determine under the Jumpstart Our Business Startups (JOBS) Act whether, as requested by the PCAOB, the standard will apply to audits of “emerging growth companies” designated by that Act.

The provisions of Auditing Standard No. 16 and of amendments to related PCAOB standards are described in PCAOB Release No. 2012-004, which is available at http://pcaobus.org/Rules/Rulemaking/Docket030/Release_2012-004.pdf.

Overview of the new requirements

In adopting Auditing Standard No. 16, the PCAOB wants to encourage effective “two-way communication” between the auditor and the audit committee by enhancing some existing PCAOB communication requirements, incorporating SEC requirements for auditor communications into the PCAOB standard, and adding new communication requirements that generally are linked to performance requirements in other PCAOB standards.

Establishment of audit engagement terms with audit committee

Auditing Standard No. 16 seeks to ensure the audit committee’s involvement in the audit process from its beginning. Under previous auditing standards, the auditor was required to establish an understanding with the company’s management regarding the audit services it would perform. Under the new standard, the auditor must establish the audit engagement terms with the audit committee and not with management. This requirement is designed to align the auditing standard with Section 301 of the Sarbanes-Oxley Act, which requires the audit committee of a listed company to be responsible for the auditor’s appointment. The new standard also requires the auditor to record the terms of its engagement in an engagement letter executed on behalf of the company with the audit committee’s acknowledgement and agreement, thereby expanding the prior requirement that the auditor simply document the understanding in its working papers.

Change to timeliness of communications

Auditing Standard No. 16 emphasizes the timeliness of the auditor’s communications with the audit committee by requiring those communications to occur before the auditor issues its report on the company’s financial statements. In contrast, AU sec. 380 did not require pre-issuance communications so long as the communications occurred on a timely basis. Under the new standard, the specific timing of communications before issuance of the audit report will depend on the nature and significance of the matters to be communicated and the nature of any corrective or follow-up actions that may be needed.

Expansion of auditor inquiries to audit committee

Auditing Standard No. 16 expands the auditor’s inquiries to the audit committee with respect to the committee’s identification and assessment of risks of material misstatements and fraud. The additional inquiries will relate to whether the audit committee is aware of violations or possible violations of laws or regulations and other matters relevant to the audit.

Addition of information to be communicated to audit committee

Auditing Standard No. 16 requires the auditor to provide the audit committee with additional information about “significant aspects of the audit” that are generally related to the results of the audit procedures or the conduct of the audit. The auditor will be required to communicate information about such matters as:

  • Overall audit strategy, including information about:

 

  • Timing of the audit, significant risks identified by the auditor, and significant changes to the planned audit strategy or identified risks; 
  • Nature and extent of specialized skill or knowledge needed to perform the audit or evaluate the audit results related to significant risks;
  • Extent of the planned use of internal auditors, other company personnel or other third parties;
  • Identities and responsibilities of other independent public accounting firms or persons not employed by the auditor that perform audit procedures during the audit period; and
  • Basis for the auditor's determination that it can serve as principal auditor, if significant parts of the audit will be performed by other auditors;
  • Critical accounting policies and practices, including information about:

 

  • Reasons that certain policies and practices are considered critical; and
  • Current and anticipated future events that may affect whether certain policies and practices are considered critical;
  • Significant unusual transactions, which are transactions undertaken outside the ordinary course of business or that are otherwise unusual, including information about the policies and practices used to account for the transactions and the auditor’s understanding of the business rationale for the transactions;
  • Qualitative aspects, which will focus on the auditor’s evaluation of the quality of the company’s financial reporting, including any identification of bias in management’s judgments about amounts and disclosures;
  • Difficult or contentious matters, which are matters for which the auditor consults outside the engagement team;
  • Going concern, which will include information relevant to the auditor's evaluation of the company’s ability to continue as a going concern;
  • Misstatements, which will address the basis for the determination that any uncorrected misstatements were immaterial;
  • Departures from the auditor's standard report, providing the reasons for any expected modification of the opinion in the auditor’s report; and
  • Other matters, which will encompass 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 and the results of the auditor’s procedures regarding those matters.  

The auditor also may provide additional information to the audit committee and respond to audit committee requests for more information.

Looking ahead

Auditors will need to move expeditiously to bring their communication schedules, documentation and process into line with the new requirements. In the near term, audit committees may wish to review the audit calendar with the auditor to confirm that the calendar will accommodate the expected timing of required auditor communications. Over the longer term, audit committees will have to be educated in a timely manner about the new standard to ensure that they obtain the full benefit of the enhanced communications. Committees should consider whether their processes for overseeing compliance matters are adequate to provide an informed response to auditor inquiries about violations or possible violations of law or regulations and other relevant matters. Some companies may find it appropriate to update their audit committee charter to identify the enhanced scope and accelerated timing of the communications required under the new standard.