On behalf of the Public Company Accounting Oversight Board, welcome to today’s roundtable.
The Board and staff of PCAOB have been actively monitoring the implementation of the internal control reporting requirements of the Sarbanes-Oxley Act, and this roundtable is an important aspect of our information gathering.
We expect the panelists will share their experiences with the internal control requirements – the nitty gritty that doesn’t always come across in the surveys that we have seen.
In that sense, this roundtable is much like the congressional testimony that Chairman Cox and I are familiar with from our days – our years, actually – in the House of Representatives.
Like the testimony that we heard from congressional witnesses, what we hear today will give us guidance for adjusting and improving the rules that govern the assessment of internal control by auditors and management.
After last year’s roundtable, the SEC and PCAOB both made mid-course corrections with respect to reporting on and the auditing of internal controls. Without prejudging anything we’ll hear today, based on the information we already have, it would seem that some further changes may be in order.
The SEC, of course, writes the rules and oversees the implementation of companies’ responsibilities for assessing and reporting on internal control. PCAOB writes the standards for and oversees the implementation of the auditors’ responsibilities with regard to internal control.
Section 404, along with the SEC’s implementing rules and the PCAOB auditing standard – Auditing Standard No. 2, or AS 2 – won’t, by themselves, drive all the necessary improvements in financial reporting. It is important to keep in mind that public companies, by their very nature, have special responsibilities to their owners-investors. Indeed, the Sarbanes-Oxley Act recognizes this by stating in its preamble that it is “an Act to protect investors by improving the accuracy and reliability of corporate disclosures….”
In furtherance of this goal, Congress was quite explicit when it mandated, in Section 404 of the Act, specific requirements for companies and their external auditors with respect to internal control over financial reporting. Yet, at the same time, Congress gave PCAOB and the SEC considerable flexibility for determining how to implement these requirements. Indeed, both Senator Sarbanes and Chairman Oxley have stressed this flexibility repeatedly.
My Board colleagues and I have always had flexibility in mind when dealing with AS 2. From the time we voted to adopt it, we’ve emphasized that the application of significant auditor professional judgment is an essential part of the standard. My sense is that auditors as well as management of public companies should exercise even more judgment as they look to the third year of implementing the internal control requirements.
My fellow Board members and I at PCAOB are particularly concerned about small audit firms that have yet to perform internal control audits. We hope to encourage these firms to continue auditing public companies by helping them prepare to implement AS 2. I believe we will succeed if we can communicate to them that AS 2 is not only flexible, but scalable, and the standard can only be properly implemented by exercising good, sound, professional judgment. A key part of any actions we take must address implementation of AS 2 in the internal control audits of smaller public companies.
PCAOB is uniquely positioned to understand how well auditors are fulfilling their responsibilities through our inspections of registered public accounting firms.
We have heard some say that our inspections have driven auditors to do more work under AS 2 than is necessary. In this regard, last week the Board announced that our inspections will focus on audit efficiency – that is, whether audits meet the objectives of AS 2 with the least expenditure of effort and resources.
In addition, our inspections, which began last week, will combine our inspections of internal control audits with our inspections of financial statement audits, much as auditors are expected to integrate their audits of internal control with the audits of the financial statements.
Consistent with past guidance, our inspectors will also be looking for top-down approaches to audits, whether auditors properly assess and respond to risk, and whether auditors use the work of others to the greatest extent that is appropriate.
We believe that focusing our inspections in this manner will be a significant step toward preserving the parts of the auditor’s work that are truly necessary and essential while cutting out unnecessary costs. Because of the importance of our inspections, some of the questions for panelists will focus specifically on our inspections program. We look forward to hearing panelists’ reactions to our 2006 inspections approach.
As our monitoring of the reporting requirements continues, the Board welcomes ideas about how the implementation of Section 404 can be made scalable to companies of all sizes. I was a general partner of a New York Stock Exchange firm that built its business around the needs of smaller businesses and investors of modest means. I firmly believe there is significant public interest in providing investors in all public companies with the same level of assurance as to the accuracy and reliability of financial reporting which, of course, is what the Sarbanes-Oxley Act is all about.
Addressing the various implementation issues in a constructive manner will require action by PCAOB, the SEC, issuers, and auditors, which must, of course, be geared toward investor protection. Whatever actions are taken will certainly be informed by today’s roundtable.