Public Company Audit Update: PCAOB Developments

• Chapter 1 - PCAOB Auditing Developments
  • Learning Objectives
  • 2008 PCAOB Standard-Setting and Other Audit-Related Activities
    • PCAOB Board Members
    • PCAOB Activities
  • Adopted and Proposed Standards
    • Final Standard: Auditing Standard No. 6
    • Proposed Auditing Standards
  • Staff Audit Practice Alert
    • Overall Audit Considerations
    • Auditing Fair Value Measurements
    • Auditing Accounting Estimates
    • Auditing the Adequacy of Disclosures
    • Auditor’s Consideration of Going Concern Matters
    • Additional Audit Considerations
  • Staff Views
  • The PCAOB’s Website
• Chapter 2 - Other PCAOB Activities
  • Learning Objectives
  • Report on the PCAOB’s 2004, 2005, 2006, and 2007 Inspections of Domestic Annually Inspected Firms
    • Description of Annually Inspected Firms
    • The Inspection Process
    • The Board’s Observations
    • Audit Deficiencies
    • Remediation of Quality Control Criticisms
  • Adopted Rules and Amendments
    • Ethics and Independence Rules
    • Rules for Annual and Special Reporting
    • Rules on Succeeding to the Registration Status of a Predecessor Firm
    • Rule Amendments Concerning the Timing of Certain Inspections of Non-U.S. Firms and Other Issues Relating to Inspections of Non-U.S. Firms
• Chapter 3 - SEC Guidance
  • Learning Objectives
  • 2008 Activity
  • On the Horizon
  • Financial Reporting Manual
  • Executive Compensation Disclosure
  • SEC Staff Views
    • Impairment Issues
    • Business Combinations and Noncontrolling Interests
    • Pushdown Accounting
    • Equity Method of Accounting
    • Convertible Debt Instruments That May Be Settled in Cash upon Conversion
    • Embedded Conversion Features and Freestanding Warrants
    • Revisions to EITF Topic D-98, Classification and Measurement of Redeemable Securities
    • Evaluation of Perpetual Preferred Securities for Other-than-Temporary Impairment
    • Share-Based Payment Awards
    • Pension Accounting
    • Kick-Out Rights
    • Related Party Considerations
    • Materiality
    • Computing Significance under Rule 3-09
    • Form S-8 and Updating Requirements
    • Experts and Consents
    • MD&A – Liquidity and Capital Resources
    • Internal Control over Financial Reporting
    • Accounting Judgments
    • International
  • SEC Staff Comments at the December 2008 AICPA National Conference on Current SEC and PCAOB Developments
  • Overview of the SEC Filing Review Process
  • Small Business Compliance Guides
  • Proxy Statements Filed in Connection with the Troubled Asset Relief Program
  • Guidance for Companies Replacing Expiring Shelf Registration Statements
  • Compliance and Disclosure Interpretations
  • Advisory Committee on the Auditing Profession
  • SEC Advisory Committee on Improvements to Financial Reporting
• Chapter 4 - Latest Developments

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Chapter 1 - PCAOB Auditing Developments

Learning Objectives

In completing this chapter you will learn about the significant matters related to

• Recent PCAOB Board personnel changes.

• Rules and standards adopted by the PCAOB during 2008:

- Final Standards
» AS 6, Evaluating Consistency of Financial Statements

- Proposed Standards » Auditor's Assessment of and Response to Risk
» Engagement Quality Review and Conforming Amendment to the Board's Interim Quality Control Standards

• Contents included on the PCAOB's website.

2008 PCAOB Standard-Setting and Other Audit-Related Activities

PCAOB Board Members

The members of the PCAOB Board currently include:

• Mark W. Olson, Chairman, former member of the Federal Reserve Board of Governors and the Federal Open Market Committee.

• Willis D. Gradison, Jr., a former Ohio Congressman (R).

• Daniel L. Goelzer, CPA and attorney, former SEC General Counsel.

• Steven B. Harris, attorney, former Staff Director and Chief Counsel of the U.S. Senate Banking Housing and Urban Affairs Committee.

• Charles D. Niemeier, CPA and attorney, former Chief Accountant of the SEC's Division of Enforcement.

Steven B. Harris was appointed to the Board in June 2008 and replaced Kayla J. Gillan who stepped down in January 2008.

PCAOB Activities

During 2008, the SEC approved the PCAOB's Auditing Standard No. 6, Evaluating Consistency of Financial Statements. AS 6 was approved by the SEC on September 16, 2008, and became effective November 15, 2008. Other standard-setting activity included the following proposed standards:

• Seven auditing standards and related conforming amendments related to the auditor's assessment of and response to risk; and

• An auditing standard on engagement quality review.

The PCAOB staff also issued one Staff Audit Practice Alert on auditing in the current economic environment and on auditing fair value measurements. In January 2009, the PCAOB staff finalized a Staff View publication on auditing internal control over financial reporting in a smaller public company.

Details on the final and proposed standards and on the staff guidance follow.

Adopted and Proposed Standards

Final Standard: Auditing Standard No. 6

Auditing Standard No. 6 (AS 6), Evaluating Consistency of Financial Statements superseded AU Sec. 420, Consistency of Application of Generally Accepted Accounting Principles and AU Sec. 9420, Consistency of Application of Generally Accepted Accounting Principles: Auditing Interpretations of Section 420. AS 6 was approved by the Securities and Exchange Commission on September 16, 2008 and became effective November 15, 2008.

This standard was issued in response to two actions of the Financial Accounting Standards Board (FASB). In May 2005, the FASB issued Statement of Financial Accounting Standards (Statement) No. 154, Accounting Changes and Error Corrections, which superseded Accounting Principles Board (APB) Opinion No. 20, Accounting Changes. Next, the FASB issued an exposure draft of a proposed Statement of Financial Accounting Standards, The Hierarchy of Generally Accepted Accounting Principles, which was subsequently approved and issued as SFAS No. 162.

Statement No. 154 establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to a newly-adopted accounting principle. Statement No. 154 also redefines the term "restatement" to refer only to "the process of revising previously-issued financial statements to reflect the correction of an error in those financial statements." Under Statement No. 154, the term "restatement" does not refer to changes made to previously-issued financial statements to reflect a change in accounting principle. AU Sec. 420, Consistency of Application of Generally Accepted Accounting Principles, the Board's interim standard on the auditor's responsibilities for evaluating the consistency of the application of generally accepted accounting principles (GAAP), generally reflected the provisions of APB No. 20, which was superseded by Statement No. 154. To better align the Board's standards with the new accounting standard, the Board proposed and then issued AS 6.

AS 6 provides guidance about the auditor's evaluation of, and reporting on, the consistency of financial statements. The standard directs the auditor to recognize, in the auditor's report, (1) a change in accounting principle or (2) an adjustment to correct a misstatement in previouslyissued financial statements, if it had a material effect on the financial statements. This standard generally reflects a clarification of the auditing standards in light of Statement No. 154 and does not establish new or additional audit requirements. The standard is meant to enhance the clarity of auditor reporting on accounting changes (including both changes in accounting principle that result from the adoption of a new accounting pronouncement and those that do not) and corrections of misstatements, by distinguishing between these events.

Further, the new standard aligns the auditor's reporting responsibilities with the accounting standards, which require disclosure of all restatements, by requiring an explanatory paragraph when the company has restated the financial statements.

Consistent with AU Section 420, changes in classification do not require recognition in the auditor's report, except for reclassifications that result from changes in accounting principle or correction of a material misstatement.

The standard also provides guidance as to the periods covered by the auditor's evaluation of consistency. These are consistent with the descriptions in AU Section 420 and therefore do not reflect a change in guidance; however, some additional examples are provided for clarification purposes.

Statement No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with U.S. GAAP. In recognition of the FASB's authority and responsibility to identify the sources of accounting principles used in the preparation of financial statements that are presented in conformity with GAAP, the FASB has incorporated the GAAP hierarchy into its own standards and, accordingly, the PCAOB has amended its interim standards to remove reference to the GAAP hierarchy in its standards. The amendments to AU Section 411 do not change the principles for evaluating the fair presentation of the financial statements in conformity with GAAP. The AICPA Auditing Standards Board (ASB) has proposed a similar amendment.

Additionally, in contemplation of other accounting principles on which auditors may report, the PCAOB has deleted AU Section 411.02, which described GAAP, and revised AU Section 411.01 to indicate that the auditor should look to the requirements of the SEC for the company under audit to identify the accounting principles that are applicable to that company. This change allows for the preparation of financial statements in conformity with international financial reporting standards (IFRS) on which the auditor reports.

Proposed Auditing Standards

Auditor's Assessment of and Response to Risk

In October 2008, the PCAOB released for comment a suite of seven auditing standards and related conforming amendments related to the auditor's assessment of and response to risk. The proposed standards provide direction on the performance of a risk-based audit through all stages, from initial planning through evaluation. These proposed standards build upon a number of other risk assessment frameworks currently in use, including the existing risk assessment framework set out in the Board's standard for the audit of internal control over financial reporting, and the risk assessment standards issued by other auditing standard setters including the International Auditing and Assurance Standards Board (IAASB) and the ASB.

These proposed standards reflect the Board's effort to reduce unnecessary differences with the risk assessment standards of other auditing standard setters. Accordingly, there is a degree of commonality between the proposed standards and the IAASB's recently updated risk assessment standards. The Board believes that such an effort is particularly appropriate in light of the foundational nature of these proposed standards and supports the Board's strategic plan to... "participate in the work of, and engage with, other auditing standards-setting bodies to benefit from, and as appropriate incorporate, new developments and techniques to promote high- quality audits worldwide."

The proposed standards recognize the importance of the risk assessment process in performing high-quality audits such that audit risk is reduced to a sufficiently low level. Audit risk is the risk that the auditor will express an inappropriate opinion when the financial statements are materially misstated. The objective of an audit of financial statements is to limit audit risk to a sufficiently low level so that the auditor can opine with reasonable assurance that the financial statements are presented fairly, in all material respects, in conformity with generally accepted accounting principles. The proposed risk standards are comprised of the following:

• Audit Risk in an Audit of the Financial Statements - The objective of the auditor in this proposed standard is to conduct the audit of the financial statements in a manner that reduces audit risk to an appropriately low level. To accomplish this objective, the auditor obtains reasonable assurance about whether the financial statements are free of material misstatement due to error or fraud.

• Audit Planning and Supervision - The objective of the auditor in this proposed standard is to plan the audit and supervise the engagement team so that the audit is conducted effectively. The proposed standard describes the auditor's responsibilities for planning the audit, including assessing matters that are important to the audit, and establishing an appropriate audit strategy and audit plan. The proposed standard also describes the responsibilities of the engagement partner and other engagement team members for supervising and reviewing the work of the engagement team.

• Identifying and Assessing Risks of Material Misstatement - The objective of the auditor in this proposed standard is to identify and appropriately assess the risks of material misstatement. The risk assessment process discussed in the proposed standard includes information-gathering procedures to identify risks (e.g., obtaining an understanding of the company, its environment, and its internal control) and analysis of the identified risks.

• The Auditor's Response to the Risks of Material Misstatement - The objective of the auditor in this proposed standard is to address the risks of material misstatement through appropriate overall audit responses and audit procedures.

• Evaluating Audit Results - The objective of the auditor in this proposed standard is to evaluate the results of the audit to form the opinion to be expressed. This evaluation includes evaluating uncorrected misstatements and control deficiencies identified during the audit.

• Consideration of Materiality in Planning and Performing an Audit - The objective of the auditor in this proposed standard is to apply the concept of materiality, as described by the federal securities laws, appropriately in planning and performing audit procedures.

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