Public Company Audit Update: PCAOB Developments

The requirements for audits of public companies continue to undergo constant change. As these changes continue to unfold over the next several years, it becomes increasingly hard for the independent auditor to keep up. Attend this course for an update on the latest standards and guidance issued by the PCAOB and others as they apply to your upcoming audits. Plus, learn what the PCAOB is planning and saying about the future so you can be out front on identifying the developments that affect your audits.

• Identify recent PCAOB rules and guidance and other developments that affect audit engagements for this reporting cycle
• Modify audit engagement planning to incorporate PCAOB changes.

Prerequisite:  Moderate experience in SEC accounting and reporting.

Chapter 1 - PCAOB Developments

Learning Objectives

In completing this chapter you will learn about

• Recent PCAOB activities.
• Rules and standards adopted by the PCAOB during 2007:
  • Final
    • AS 5, An Audit of Internal Control over Financial Reporting That is Integrated With An Audit of Financial Statements.
    • Frequency of inspections.
  • Proposed
    • Evaluating consistency of financial statements.
    • Ethics and independence rules concerning independence and tax services.
• The PCAOB's website.

2007 PCAOB Rulemaking and Other Activity

Recent Personnel Changes

The members of the PCAOB currently are

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

Kayla J. Gillan, a board member since the inception of the PCAOB, stepped down in January 2008. Greg Scates succeeded Laura Phillips as one of the two Deputy Chief Auditors in 2007.

PCAOB Activities

During 2007 SEC approved Auditing Standard No. 5, An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements (AS 5), as a replacement for AS 2, An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements. AS 5 is effective for audits of ICFR for fiscal years ending on or after November 15, 2007. AS 5 is a principles-based standard that is designed to allow auditors to exercise professional judgment in focusing effort on those areas that present the greatest risk of a material misstatement occurring in the financial statements, and in reducing testing in those areas of lowest risk. Further, the standard eliminates audit requirements that were considered unnecessary to achieve the intended benefits as well as provides direction on how to scale the audit for smaller and/or less complex companies.

Final rules issued in 2007 were as follows:

• - Final Rule 3525 - Audit Committee Pre-approval of Non-Audit Services Related to Internal Control Over Financial Reporting - In association with AS 5, the Board issued a new independence rule on auditor independence and internal control services. Rule 3525 requires the auditor to provide both written and oral communications of the scope of the work to be performed and documentation of the substance of the auditors' discussion with the audit committee regarding non-audit services.
• Amendment to AU Section 530, Dating of the Independent Auditor's Report - Also in association with AS 5, the Board amended the existing requirement on dating the auditor's report. Previously, the auditor's report was dated generally at "the date of completion of the fieldwork." Now the auditor's report should be dated "no earlier than the date on which the auditor has obtained sufficient competent evidence to support the auditor's opinion."

Also in 2007, the PCAOB adopted two amendments to adjust the frequency with which it is required to inspect certain firms. The Board removed the PCAOB imposed requirement for regular periodic inspections of registered public accounting firms that play a "substantial role" in an audit as well as amended the rules on inspection frequency for firms that audit a small number of public clients. On November 2, 2007, the SEC issued an order formally approving the PCAOB amendments.

Proposed rules issued in 2007 were as follows:

• AS 6, Evaluating Consistency of Financial Statements, was proposed with conforming amendments to the Boards' Interim Standards on January 29, 2008. AS 6 provides clarification of the auditing standards in light of the issuance of FAS 154, Accounting Changes and Error Corrections and the impending issuance of Financial Accounting Standards on The Hierarchy of Generally Accepted Accounting Principles. AS 6 will become effective subject to the approval of the SEC.
• Rule 3526, Ethics and Independence, was also amended in 2007. The amendment would require the auditor to describe in writing to the audit committee all relationships, potential effect of these relationships, and document the substance of its discussion. In addition, the auditor would be required on an annual basis to affirm to the audit committee that the auditor is independent in compliance with Rule 3520. Rule 3523 with respect to tax services for persons in financial oversight roles was also amended in 2007. The Board decided not to restrict the provision of tax services during the portion of the audit period that precedes the professional engagement period to preserve auditor independence. As a result of this proposal the Board decided that it would not apply Rule 3523 to tax services provided on or before April 30, 2008.

Final Rules and Standards Approved by the SEC in 2007

Final Standard: AS 5

AS 5 was approved by the SEC in July 2007 as a replacement for AS 2. AS 5 is effective for audits of ICFR for fiscal years ending on or after November 15, 2007. AS 5 is a principles-based standard that is designed to allow auditors to exercise professional judgment in focusing effort on those areas that present the greatest risk of a material misstatement occurring in the financial statements, and in reducing testing in those areas of lowest risk. Further, the standard eliminates audit requirements that were considered unnecessary to achieve the intended benefits. The standard also provides direction on how to scale the audit for a smaller and/or less complex company or portions thereof. The highlights of AS 5 are as follows:

• Top-down approach - The standard emphasizes this approach, which was referred to in the PCAOB's May 2005 guidance. AS 5 goes further, in that it allows the auditor to determine that entity level controls may be sufficient to address the risk of misstatement related to a particular relevant assertion when such entity level controls operate at a sufficient level of precision.
• Large portion requirement - AS 5 removed the requirement to test a "large portion" based on a coverage concept, and instead incorporates a risk-based assessment of locations and/or financial statement areas to test.
• Risk assessment - AS 5 emphasizes the auditor's assessment of risk and the use of risk assessment in the selection of controls to test. As a result, there is an expanded discussion of the relationship of risk to the evidence necessary to conclude that a given control is effective. Further, there is expanded guidance on the auditor's assessment of the risk of fraud, including identification and testing of controls to address the risk of material misstatement due to fraud and due to management override.
• Integration with the financial statement audit - The standard directs the auditor to consider the results of substantive audit procedures performed in the financial statement audit when determining the overall risk related to a control. However, controls must be directly tested and effectiveness cannot be inferred solely from the absence of misstatements detected by the auditor in the substantive testing relative to the financial statement audit.
• Revision of certain definitions - The definitions of "material weakness" and "significant deficiency" were revised as discussed above and are consistent with those included within the SEC's rules.

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