On July 25, the Securities and Exchange Commission voted unanimously to approve the Public Company Accounting Oversight Board's (PCAOB) proposed Auditing Standard No. 5, An Audit of Internal Control Over Financial Reporting That is Integrated With An Audit of Financial Statements (Auditing Standard No. 5), a related independence rule, and conforming amendments. The SEC also adopted a definition of the term “significant deficiency.”

Auditing Standard No. 5 will replace PCAOB Auditing Standard No. 2, An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements (Auditing Standard No. 2). It provides for new professional standards and related performance guidance for independent auditors to attest to, and report on, management's assessment of the effectiveness of internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act of 2002. According to the SEC, Auditing Standard No. 5:

  • Is less prescriptive than Auditing Standard No. 2.
  • Makes the audit scalable - so it can change to fit the size and complexity of any company.
  • Directs auditors to focus on what matters most - and eliminates unnecessary procedures from the audit.
  • Includes a principles-based approach to determining when and to what extent the auditor can use the work of others.

The SEC also adopted a definition of “significant deficiency” to define this term as a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the registrant's financial reporting. This definition is used in the context of evaluating the required communications under both Sections 302 and 404 of the Sarbanes-Oxley Act and the SEC's implementing rules.

The SEC also approved PCAOB Rule 3525, which further implements Section 202 of the Sarbanes-Oxley Act's pre-approval requirements by requiring auditors to take certain steps as part of seeking audit committee pre-approval of internal control related non-audit services. The other conforming amendments approved by the SEC update the PCAOB's other auditing standards.

The new auditing standard and other measures are expected to increase the accuracy of financial reports while reducing unnecessary costs, especially for smaller public companies.