New Financial Audit Standard Encourages Oversight

The Public Company Accounting Oversight Board on Financial Audit (PCAOB) today approved a standard on how to help Accountants and audit committees communicate better. While Auditing Standard No. 16 (dubbed Communication with Audit Committees) still has to be approved by the Securities and Exchange Commission, the formal adoption of the rule shows the importance the PCAOB is placing on the need for better communication to improve the transparency and integrity of financial reporting by U.S. companies.

Requiring better financial audit communication is expected to help smooth out any wrinkles that might arise in advance of a company’s financial-reporting cycle. It is to the benefit of a company and its financial audit committee to hear upfront about concerns that might spring up over applying new accounting standards or about any unusual financial transactions that are outside of the normal course of business rather than when a company is about to release its earnings. It’s really putting them companies on notice that there’s a risk around financial reporting that we see emerging here.”

Under the new Financial Audit Standard, an Accountant would also be required to ask a company what plans it has to mitigate a particular issue before formulating his or her conclusion, which would mark a change from current practice. “This significantly puts the audit committee into the equation and consideration of what the Accountant is doing.

The Accountant would also have to tell the audit committee about significant risks he or she may have identified and update the audit committee about changes he or she may have to the overall strategy of the audit. If any departure from a standard Accountant report is necessary, that would also have to be shared with the audit committee.

Some audit committees may find the new communication process more helpful than others. “Audit-committee members who have had backgrounds as CFOs [and] former Accountants really know what information they want and what to ask for, but other audit-committee members may not. This in a way is leveling the playing field so that everyone would get the same type of information.

The PCAOB does not have jurisdiction over corporate audit committees; instead, it would only oversee the way Accountants will have to communicate with it going forward. If adopted by the SEC, AS 16 would go into effect for public-company audits of fiscal periods beginning after December 15, 2012.

The new Financial Audit standard became a priority at the board because of a perceived need to improve transparency in the entire audit process, from the development of company financial statements to the deliberations of audit committees to PCAOB inspections. PCAOB board member Jay Hanson notes that the oversight body should share as much as possible about its insights into public-company auditing. It’s clear that at least some audit-committee members are doing an outstanding job, exactly what the Sarbanes-Oxley Act envisioned, and I think part of our job is to help other audit-committee members to get to that high level. Sarbanes-Oxley requires that the audit committee be independent of company management.

The board originally proposed the standard in March 2010, and then worked on a revision at the end of 2011. AS 16 also builds on previous interim PCAOB standards that became effective in 1989, including AU Section 380, the first “Communication with Audit Committees,” and AU Section 310, called the “Appointment of the Independent Accountant.”

The new standard focuses on “communication with the audit committee, not necessarily information sent to the audit committee. “We’re mindful of this standard potentially becoming just another checklist or boilerplate exercise of going through a list of requirements. We heard from commentators who didn’t want that and we’ve been responsive to those comments.

One criticism of AS 16 lies in letting Accountants communicate orally with audit committees, instead of just requiring written documentation. Despite the oral presentations, however, the Accountant would still have to document what would have been in the report.

The cost to adopt the new standard, however, remains a low concern. The PCAOB says communication between Accountants and audit committees can be scaled up or down to fit the size of a company.