Annual Public Company Update: SEC, PCAOB, and AICPA Developments

The requirements for public companies, their management, and their auditors continue to change rapidly. As these changes unfold over the next several years, how will you — the corporate financial reporting manager or independent auditor — keep up? CPAs involved with SEC accounting and reporting responsibilities as well as independent auditors of SEC issuers will find this course of great benefit.

Highlights include: coverage of recent SEC changes to reporting dates, forms and disclosures; new SEC guidance that could directly affect company management and auditors; PCAOB developments; what SEC and PCAOB leaders currently are saying; recent actions by COSO, the AICPA, the top auditing firms and others; emerging issues and trends and learn of new resources; and more.

Identify recent SEC and PCAOB rules and guidance as well as other developments that affect filings or engagements for this reporting cycle

Prerequisite: Moderate experience in SEC accounting, reporting, or auditing

Overview

Summary of Significant SEC and PCAOB 2006 Developments

In 2006, the Securities and Exchange Commission and its staff continued to focus on evaluating the results of issuers' and auditors' efforts to implement the internal control reporting requirements of Section 404 of the Sarbanes-Oxley Act of 2002. The SEC also made time to complete two important initiatives on executive compensation disclosure and evaluating the materiality of errors in financial statements. The 2005 reporting year was the second year that accelerated filers and their auditors were required to report on the effectiveness of internal controls in their annual reports. The second year was generally less difficult and less costly than the first year, but everyone involved in the process - management, auditors, the SEC, and the PCAOB - continued to believe that the process should and could be improved.

This course provides details on the 2006 SEC and PCAOB activities described below.

The course is organized as follows:

• Chapter 1 - SEC Final and Proposed Rules Issued
• Chapter 2 - SEC Guidance
• Chapter 3 - PCAOB Developments
• Chapter 4 - PCAOB Guidance
• Chapter 5 - 2006 Accounting Year in Review

Section 404 Implementation

In May, the SEC and PCAOB held a public roundtable to obtain feedback from constituents on the second year of Section 404 implementation. Based on this feedback and their experience with the Section 404 requirements, the Commission and the PCAOB issued statements about steps they planned to take to improve implementation of internal control reporting.

The Commission outlined its action plan as follows:

• Issue guidance on management's assessment of internal control over financial reporting (ICFR) based on
  • Information to be obtained from an SEC concept release on management's reports on ICFR and the Committee of Sponsoring Organizations' (COSO) guidance on how to apply its framework in smaller public companies.
  • Feedback already obtained from the May roundtable; the SEC's Advisory Committee on Smaller Public Companies; and the U.S. Government Accountability Office April 2006 Report, Sarbanes-Oxley, Consideration of Key Principles Needed in Addressing Implementation for Smaller Public Companies.
• Defer the 404 compliance dates for non-accelerated filers;
• Work with the PCAOB to revise Auditing Standard No. 2, An Audit of Internal Control over Financial Reporting in Conjunction with an Audit of Financial Statements, to make it work efficiently and effectively for audits of companies of all sizes; and
• Oversee the PCAOB inspection program that includes reviewing whether auditors have efficiently performed ICFR audits.

Exhibit 0-1 summarizes the action plan.

The PCAOB's plan included the following:

• Amend AS 2 to ensure that audits of the financial statements and ICFR are integrated and that ICFR audits use a top-down and risk-based approach;
• Reinforce auditor efficiency through inspections;
• Develop and implement guidance and training for auditors of small companies; and
• Continue PCAOB forums on auditing in the small business environment.

In November, the Committee on Capital Markets Regulation (also known as the Paulson Committee) provided input that targeted Congress as well as the SEC and other regulators. The Committee recommended that the SEC and other regulators move to a more risk-based regulatory process, and that regulators should rely on principles-based rules and guidance. Also, the Committee commented that small companies should be exempted from Section 404 if it's too burdensome to implement. (The Committee's recommendations are available at http://www.capmktsreg.org/index.html.) The SEC's Advisory Committee on Smaller Public Companies had made a similar recommendation in April when it commented that smaller public companies should be exempted from Section 404 requirements until a cost-effective framework for assessing ICFR for these companies is developed.

The Commission is particularly concerned about the costs and other difficulties that smaller companies and foreign companies face in implementing Section 404. The SEC believes that it is inappropriate to require compliance with the 404 requirements before a cost-effective means of assessing and auditing the controls is developed. Consequently, the Commission deferred the auditor reporting on management's assessment of ICFR for accelerated foreign private issuers for one year, to years ending on or after July 15, 2007.

The SEC finalized rule amendments to defer implementation of Section 404 for non-accelerated and newly public companies. The SEC extended the effective date for the management of non- accelerated filers to report on ICFR five months to fiscal years ending on or after December 15, 2007, and deferred auditor reporting on management's assessment until fiscal years ending on or after December 15, 2008. The SEC also determined that reporting on internal control created an undue burden on newly public companies and amended the rules to allow such companies to begin providing management and auditor reports on ICFR in their second annual report.

In December, the SEC issued proposed interpretive guidance for management to assess ICFR that focuses on two primary tasks:

• The evaluation of the design of controls; and
• The gathering of evidence of operating effectiveness.

The SEC believes the assessment of the design of controls should use a top-down, risk-based approach that is focused on the possibility of material misstatement. The approach to evaluating operating effectiveness is based on the concept that the greater the risk of material misstatement the more robust the evidence should be, and that the evaluation methods need to be tailored to a company's specific facts and circumstances.

As a companion to the SEC's proposed guidance, the PCAOB issued a proposed new auditing standard that will replace (not amend) AS 2. The objective of the standard is to increase ICFR audit effectiveness and efficiency by focusing the audit, eliminating unnecessary procedures, scaling the audit for smaller companies, and simplifying the audit requirements. The proposed standard is designed to address concerns that AS 2 is too prescriptive and to allow for focus and scalability.

Rules Issued

In 2006, the Commission also completed a number of rulemaking initiatives. In August, it completed new executive compensation disclosure rules. These rules redefine the executives whose compensation must be disclosed, require a new total in the Summary Compensation Table; supplement the Summary Compensation Table with a Grants of Plan-Based Awards Table; require a new MD&A-like analysis of compensation - Compensation Discussion and Analysis; add five tables - Outstanding Equity Awards at Fiscal Year End, Option Exercises and Stock Vested, Pension Benefits, Nonqualified Deferred Compensation, and Director Compensation; and require narrative disclosure of post-employment compensation payments. The Commission modified these disclosures in December to conform the disclosure in the Summary Compensation Table of stock and option awards costs to the costs reported in the financial statements over the requisite service period in accordance with FASB Statement No. 123 (Revised 2004), Share-Based Payment.

In September, the staff provided long-anticipated guidance on evaluating materiality of errors in financial statements in Staff Accounting Bulletin (SAB) No. 108, Quantifying Misstatements in Financial Statements. The SAB requires issuers to use both of the two approaches (iron curtain and rollover) that are currently used. It requires issuers to adjust their financial statements if either approach results in a conclusion that an error is material. The SAB could significantly affect many companies' financial statements.

The Commission and its staff devoted significant attention to the stock option backdating issue. In September, the Chief Accountant of the SEC explained the staff's views on the accounting consequences of issues that can arise when investigating past stock option granting practices. The staff's views were provided in a letter that focused on the accounting consequences under APB Option No. 25, Accounting for Stock Issued to Employees, of options granted with backdated award dates, administrative delays, uncertain validity, and other related issues. In January 2007, the staff of the Division of Corporation Finance provided guidance on filing amendment and disclosure requirements when financial statements for multiple years must be restated.

During 2006, the Commission continued to promote the use of Extensible Business Reporting Language (XBRL). SEC Chairman Christopher Cox is very interested in using technology to improve the usefulness of financial information to investors and in furthering the use of XBRL for financial reporting. Chairman Cox and the Commission hope to expand participation in the voluntary program to provide XBRL financial information, and announced a $54 million initiative to transform the SEC's electronic filings database into an interactive tool based on XBRL.

In 2007, the Commission and its staff will continue to review the implementation of International Financial Reporting Standards. The staff has already begun its review of the first wave of financial statements prepared on the basis of IFRS for 2005, the first year that many European companies were required to implement IFRS in their primary financial statements. Based on the SEC's action plan for U.S. and IFRS convergence (also know as the "roadmap"), IFRS could coexist without reconciliation to U.S. GAAP in the U.S. capital markets by 2009.

The SEC's Website

The SEC publishes news about itself on its website, located at www.sec.gov. The home page of the site is organized as follows:

• About the SEC (contains links to the securities laws)
• EDGAR Filings and Forms (contains database of all EDGAR filings)
• Regulatory Actions (Final and Proposed Rulings and other SEC rulemaking)
• Staff Interpretations (Staff Accounting Bulletins and Staff Legal Bulletins)
• Investor Information (assistance and complaint center)
• News and Public Statements (speeches, press releases, and news digests)
• Litigation (includes Accounting and Auditing Enforcement Releases (AAERs))
• SEC Division Homepages

The home page also has links specific to the needs of accountants, broker dealers, and filers, including rules and forms applicable to small business or "SB" filers. To the far left of the home page is a listing of the most recent news, rulemaking, enforcement actions, or other items of interest to the public.

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