Audit Committees: PCAOB Adopts New Auditing Standard Related to Communications Between Auditors and Audit Committees

Sullivan & Cromwell LLP - September 11, 2012

The Public Company Accounting Oversight Board has adopted Auditing Standard No. 16, Communications with Audit Committees, a new auditing standard addressing communications between auditors and audit committees that is intended to improve audits by enhancing the relevance and quality of these communications throughout the audit. The new standard will, if approved by the SEC, supersede the existing interim standards included in AU sec. 380 and AU sec. 310. Under the new standard, the auditors must communicate, among other things, the following to the audit committee in a timely manner and prior to the issuance of the auditor’s report:

  • an overview of the overall audit strategy, including the timing of the audit, significant risks the auditor identified, and significant changes to the planned audit strategy or identified risks;
  • significant transactions that are outside the ordinary course of business or unusual and the auditor’s understanding of the business rationale for such transactions;
  • difficult or contentious matters for which the auditor has consulted outside the engagement team;
  • complaints or concerns regarding accounting or auditing matters that have come to the auditor’s attention;
  • a description of the process management used to develop critical accounting estimates, including the significant assumptions underlying highly subjective estimates;
  • information about other accounting firms or accountants involved in the audit, and the basis upon which the auditors can serve as principal auditor if significant parts of the audit will be performed by affiliates or other auditors; and
  • other matters arising out of the audit that are significant to the oversight of the company’s financial reporting process.

In addition, when conducting a quarterly review of interim financial information, the auditor should determine whether any of the matters described in the new standard, as they relate to interim financial information, have been identified and, if so, should communicate them to the audit committee prior to the company filing its Form 10-Q with the SEC.

The new standard also seeks to encourage effective two-way communication between the auditor and audit committee and, in this regard, requires the auditor to inquire of the audit committee whether the audit committee is aware of matters that are relevant to the audit, including its knowledge of violations or possible violations of laws or regulations.

The PCAOB also adopted a transitional amendment to AU sec. 380 that makes the communication requirements in AU sec. 380 applicable to the audits of SEC-registered brokers and dealers in the event that the SEC’s proposal to subject broker-dealer audits to PCAOB standards is adopted and goes into effect before the effective date of the new PCAOB standard.

Auditing Standard No. 16 and related amendments are subject to SEC approval. Subject to this approval, the PCAOB anticipates that the new standard will be effective for audits and quarterly reviews for fiscal years beginning on or after December 15, 2012. In addition, this is the first new PCAOB standard adopted since the enactment of the Jumpstart Our Business Startups Act and will apply to the audits of “emerging growth companies” (as defined under such act) only if the SEC determines that such application is necessary or appropriate in the public interest.

Although the new standard is directed at auditors, not issuers, SEC-reporting companies should evaluate the extent to which their audit committee agendas and, potentially, their audit committee charter should be updated to take into account the new required communications. Companies may determine to integrate this evaluation with an analysis of the guidance recently issued by the PCAOB as to the audit firm inspection process, which highlights several inspection-related areas that audit committees may wish to address in communications with auditors.